ONE YEAR ON: The $17B Write Down of the Credit Suisse AT1 Bonds
In the twelve months prior to the UBS takeover, Credit Suisse had lost 75% of its value with $75 billion of customer deposits lost in the first quarter of 2023 and was heading towards collapse in what would have been one of the largest banking failures since the fall of Lehman Brothers in 2008. Swiss National Bank Chairman, Thomas Jordan, explained that if UBS and the Swiss state had not stepped in, "Credit Suisse would have failed, with extreme consequences for Switzerland but also the global economy".
As part of the UBS takeover, FINMA (the Swiss Financial Market Supervisory Authority) ordered Credit Suisse to write down in full all Additional Tier 1 capital instruments ("CS AT1 Bonds") with a combined value of around $17.3 billion (the "Write-Down"), making this the largest loss in the $275 billion AT1 bond debt market to date, as reported by Reuters.
This alert considers the potential AT1 Swiss claims in connection with the Write-Down and highlights some of the key legal risks for investors in the secondary market.
What are AT1 Bonds?
AT1 bonds, sometimes referred to as "contingent convertible" or "CoCo" bonds are a form of hybrid debt introduced by banks following the global financial crisis. AT1 Bonds can be lucrative, generating high yield returns in times of prosperity, but by nature, AT1 Bonds are the riskiest type of bond a bank can issue, as reported by Reuters, designed to absorb losses by being written down or converted into equity when a bank's capital ratios drop below a certain level. AT1 Bonds play a key regulatory role in forming part of the capital banks are required to hold against potential loan losses in order to comply with Basel III requirements.
Claims in relation to the Write-Down of Credit Suisse AT1 Bonds:
FINMA's decision to deviate from the established process of granting bondholders priority over equity holders by writing down the value of the CS AT1 Bonds to zero while Credit Suisse shareholders were set to receive $3.2 billion under the UBS deal, shocked the AT1 Bond market.
A similar set of facts occurred in the only other AT1 Bond write down to date, in which Bloomberg reported that €1.35 billion of AT1 Bonds held in Spanish lender Banco Popular SA were written down to zero, when it was absorbed by Banco Santander SA in 2017 to avoid collapse. However, in this situation, unlike the UBS Takeover, the equity in Banco Popular SA was also written off, in line with corporate finance hierarchies.
Since the March 2023 Write-Down, among others, two groups of CS AT1 bondholders, spearheaded by Quinn Emanuel Urquhart & Sullivan LLP and Pallas Partners LLP, have filed appeals against FINMA's Write-Down order with the Swiss Federal Administrative Court in an effort to recoup their losses from the Write-Down (the "FINMA Appeal"). Under the FINMA Appeal, CS AT1 bondholders are seeking for the court to declare the Write-Down Order as illegal and to reinstate the AT1 Bond debt instruments.
CS AT1 bondholders may also have the ability to bring other claims in Switzerland against UBS as legal successor to Credit Suisse and/or against the Swiss Confederation in respect of the Write-Down. Such claims are yet to be made and, as the fallout from the Write-Down continues to unfold, the process of filing contractual claims, claims in relation to bilateral or multilateral investment treaties of Switzerland and the outcome of the FINMA Appeal and any future claims are yet to be fully known.
Methods of transferring CS AT1 Bonds and accompanying litigation claims:
The following options are available:
1) Participation: As a concept, participations and subparticipations are not entirely unknown under Swiss law, but have not been tested before Swiss courts in circumstances like the ones at hand. Under Swiss administrative law, standing requirements are not black or white but rather gradual in nature. Therefore, as a rule, standing in Swiss administrative procedures is not tradeable without counterparty consent (subject to certain exemptions). Against this background, participations and sub-participations are intended to allow participants to receive the benefits of any existing claims the grantor is involved in. Granting a participation to CS AT1 Bonds and the associated claims aims at retaining the Write-Down Date Holder's legal title to the CS AT1 Bonds and thereby mitigating the risk of a loss of standing in the FINMA Appeal, of which the participant will have the right to any equivalent economic benefit.
2) Assignment: Contrary to the grant of a participation to CS AT1 Bonds, an assignment of CS AT1 Bonds results in a transfer of title. Such assignment will, as a rule, not transfer the benefit of any Swiss administrative claims to the assignee. Assignments may instead be utilised by buyers of CS AT1 Bonds where the buyer wishes to bring future contractual claims in their own name, depending on the specific nature and legal basis of the claim. To make a valid assignment of CS AT1 Bonds vis-à-vis Credit Suisse and/or UBS, the assignment agreement must be Swiss law governed in accordance with Swiss conflict of law rules. Swiss law governed assignment agreements must be signed in wet ink by the parties in order for the assignment to be legally binding and the new buyer may be required to demonstrate its valid chain of title in any new litigation.
CLAIMS TRADING OF CS AT1 BONDS Q&A WITH VISCHER (click here)
For more information on claims trading of CS AT1 Bonds and detailed guidance from Swiss counsel, Vischer, please refer to our CS AT1 claims trading Q&A.
SPECIAL THANKS
We appreciate the assistance of Dr. Markus Guggenbühl, Dr. Sandro Bernet and Maximilian Riegel of Vischer with the preparation of this update on Swiss law, regulation, and practice.
CLAIMS TRADING: SECONDARY MARKET NEWS FTX Bankruptcy Claims
On 11 November 2022 and 14 November 2022, FTX Trading Ltd ("FTX Trading"), once one of the largest cryptocurrency exchanges, and 101 affiliated companies filed a voluntary petition for relief under Chapter 11 of the United States Bankruptcy code in the United States Bankruptcy Court for the District of Delaware, as published by Kroll. Prior to the FTX Trading Chapter 11 filing, on 10 November 2022, the Securities Commission of the Bahamas froze all assets of FTX Digital Markets Ltd. ("FTX Digital") in the Bahamas and petitioned to place FTX Digital into provisional liquidation.
Reuters reported that approximately $16 billion in customer funds were held on the FTX exchange prior to its collapse. Customers who were unable to withdraw their funds during the collapse of FTX were required to file proof of claims against FTX Trading with the United States Bankruptcy Court by 29 September 2023.
FTX DIGITAL MARKETS LTD.: FILING DEADLINE 15 MAY 2024
On 15 February 2023, the United States Bankruptcy Court recognised the provisional FTX Digital liquidation as a foreign main proceeding under Chapter 15 of the US Bankruptcy Code with PwC, the official liquidator overseeing FTX Digital's liquidation proceedings, confirming that FTX Digital "has successfully negotiated a landmark settlement with FTX Trading Ltd and its affiliated debtors" under the Chapter 11 Proceedings (link here to the full PwC press release). The aim of such settlement is to consolidate the assets of both FTX Digital and FTX Trading so that the Bahamian liquidation process ensures customers receive "substantially the same return at the same time in both the Bahamas process and the US process" (link here for the PwC FTX Digital webpage).The deadline for customer and non-customer creditors of FTX Digital to submit their proof of claim is 15 May 2024.
Although repayments under the FTX proceedings are not guaranteed, during a court hearing on 31 January 2024, FTX lawyer, Andrew Dietderich stated that FTX expects to have sufficient funds to pay all customers in full. The repayment to customers will be for the value of their assets based on cryptocurrency prices as of November 2022 (the time of the Chapter 11 filing). Despite Reuters reporting that some customers have complained that the repayments should be calculated based on today's prices to reflect the recovery of the cryptocurrency market since November 2022, US Bankruptcy Judge, John Dorsey, ruled that bankruptcy rules require a company's debts to be tied to the date it filed for court protection (see Bloomberg article linked here).
As the outlook of receiving significant recoveries under the FTX claims has become increasingly more positive, interest in trading such claims continues, with FTX claims trading at around 55 to 96.5 cents on the dollar in the claims secondary market according to current X Claims marketplace figures (see link here).
SWISS LEGAL SYSTEM
Switzerland's political system is based on the principles of federalism and direct democracy. The political system is three tiered:
- the Swiss confederation;
- cantons (26); and
- municipalities (around 2,140)
The Swiss legal system is based on civil law. As with other civil law legal systems, Swiss law is divided into public law and private law. Private law (such as contractual and company laws), insolvency and bankruptcy laws, securities laws, and financial market regulation are predominantly dealt with on a federal level. The cantons and, to a lesser extent, the municipalities enjoy a certain degree of autonomy within the limits of the federal constitution and federal laws in many areas. These areas include cantonal and municipal taxes, certain public law matters and the administration of the cantonal courts.
KEY POINTS FOR TRADERS
- interest payments unless the loan owed by the Swiss company qualifies as a bond. The 10/20 Non-Bank Lender Rule is the determining factor for the imposition of withholding tax and stamp duty (a reform of the Swiss withholding tax, which would also have abolished the 10/20 Non-Bank Lender Rule, was rejected by the Swiss people in a 2022 referendum). For further information regarding the 10/20 Non-Bank Lender Rule, please refer to our previous Swiss Trade Alert linked here.
- The Swiss domestic rules regarding withholding tax on interest payments are normally overruled by double tax treaties, which provide that interest arising in one contracting state and paid to a resident in the other contracting state is only taxable in the state where the recipient of the interest is residing. Only a few double tax treaties allow the contracting state where the interest paying party is resident to withhold a withholding tax.
- Generally, foreign parties lending to Swiss companies do not require a banking licence.
- The method(s) available for transfers/assignments are provided for in the loan/security documentation. Additional transfer formalities may apply depending on the chosen method but typically these are satisfied by default in the loan documentation.
- The concept of a security agent is commonly used in Switzerland. It is also common, for additional protection, to put in place a "parallel debt" structure.
BANKING LICENCE REQUIREMENTS
No banking licence is required for foreign parties making commercial loans to borrowers in Switzerland, provided the foreign parties do not have a physical presence in Switzerland. However, this does not apply to consumer loans where licensing requirements apply.
As of 1 January 2020, under the Swiss Financial Services Act and the Ordinance on Financial Services, loans granted for the purposes of acquiring financial instruments, such as securities (e.g. margin loans and similar loans) are classified as "financial services". Consequently, Swiss and foreign professional financial service providers granting loans in Switzerland or to clients in Switzerland will be subject to certain duties in connection with their lending activities, irrespective of any physical presence.
SECURITY AND TRUSTS / AGENCY
Swiss law does not have the concept of a trust. However, the Hague Convention on the Law Applicable to Trusts is applicable to transactions in Switzerland. This means that foreign trusts may be considered valid and recognizable in Switzerland. While this paved the way to a proposal to introduce the concept of a Swiss trust in the Swiss Code of Obligations, the proposal was rejected by the Federal Council in September 2023.
Parallel debt structures are commonly used but have yet to be tested in Swiss courts.
The security agent's ability to enforce its rights will depend on the nature of the security:
1) Pledge: The doctrine of accessory (Akzessorietätsprinzip) applies to pledges under Swiss law. As such, a pledgee must be the creditor holding the secured claim. A pledge must be granted to the lender(s) and cannot vest in a third party acting as a security holder in its own name and right. However, the lender(s) can be represented by a third party (security agent) acting on their behalf.
2) Security assignment or security transfer: The doctrine of accessory (Akzessorietätsprinzip) does not apply. Consequently, a security agent can enter into the security agreement and hold the security in its own name and on its own account for the benefit of other lender(s).
TAX AND STAMP DUTY CONSIDERATIONS
There is generally no withholding tax payable on loan interest payments nor is Swiss securities transfer tax payable in relation to loans unless the loan qualifies as a bond.
The definition of the term "bond" is decisive in the application of this rule.
- A bond (Anleihensobligation) denotes a standardised, closed financing transaction. Debt financing qualifies as a bond if a borrower, considered a tax resident in Switzerland, raises debt under identical terms, exceeding CHF 500,000 from more than 10 non-bank lenders, against the issuance of promissory notes.
- Debt financing is designated as a mediumterm note (Kassenobligation) if a borrower, regarded as a tax resident in Switzerland, raises debt under variable terms, surpassing an amount of CHF 500,000 from more than 20 non-bank lenders.
The Swiss domestic rules regarding withholding tax on interest payments are normally overruled by double tax treaties which provide that interest arising in one contracting state and paid to a person resident in the other contracting state may, if that person is the beneficial owner, be taxed only in the other state. Only a few double tax treaties limit the residual withholding tax to 5-15 per cent.
For companies resident in Switzerland receiving interest payments, the applicable combined corporate income tax rate varies between 12 - 21 per cent. Generally, Swiss companies may fully reclaim the withholding tax provided certain conditions are met.
It is also important to consider the situation where both the Swiss confederation and the cantons impose a withholding tax on interest payments to foreign creditors which are secured by pledges on Swiss properties. This withholding tax may be avoided or reduced provided a double tax treaty applies.
NOTARY REQUIREMENTS
The creation and amendments of security interest on real estate located in Switzerland, i.e. mortgage note and land charge, require a public deed to be drawn by a public notary and a registration in the land register.
The two most common forms of security over real estate in Switzerland are:
1) Mortgage Certificate (Schuldbrief): This includes both the personal claim and the security. It is a negotiable instrument. Mortgage certificates are the instruments most commonly used in financial transactions because once created they are easily transferred and pledged without the intervention of a notary.
2) Land Charge: This is a simple mortgage registered with the land register. Importantly, the land register registration only outlines the security and the secured party. The secured claim itself is not registered in the land register. The claim and the security interest are also not evidenced in a negotiable instrument
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.