UBS to Face Investor Lawsuits Over Credit Suisse Demise: A Deep Dive into the AT1 Bond Controversy
The downfall of Credit Suisse in March 2023 sent shockwaves through the global financial system. Now, UBS, the bank that acquired Credit Suisse in a government-brokered rescue deal, is facing the legal repercussions of its predecessor’s alleged misconduct. A recent ruling by a U.S. judge has allowed two separate lawsuits filed by investors to proceed, alleging that Credit Suisse made false and misleading statements about its financial health in the lead-up to its collapse. This article will delve into the details of these lawsuits, the controversial write-down of Credit Suisse’s Additional Tier 1 (AT1) bonds, and the broader implications for the banking industry.
Legal Battleground: The Investor Lawsuits Against UBS
U.S. District Judge Colleen McMahon in Manhattan has given the green light for two distinct lawsuits against UBS to move forward. The first lawsuit, spearheaded by Core Capital Partners, represents U.S. investors who purchased Credit Suisse’s AT1 bonds. The second lawsuit, which Judge McMahon previously declined to dismiss in September, is brought by U.S. purchasers of Credit Suisse’s American depositary shares (ADS) and other bond issues, who will proceed as a class action.
Core Capital’s AT1 Bond Lawsuit
The lawsuit filed by Core Capital centers around the controversial decision by the Swiss financial regulator, FINMA, to write down Credit Suisse’s AT1 bonds to zero as part of the UBS rescue. AT1 bonds are designed to absorb losses and bolster a bank’s capital during times of financial stress. They rank higher than common equity in the capital structure, but the FINMA write-down effectively wiped out billions of dollars in investor value, sparking outrage and legal challenges.
Class Action Lawsuit for ADS and Other Bondholders
The second lawsuit represents a broader group of investors who purchased Credit Suisse’s ADS and other bond issues. These investors claim that Credit Suisse’s misleading statements about its financial condition artificially inflated the value of these securities, resulting in significant losses when the bank’s true financial state was revealed.
Judge McMahon has opted to keep the two lawsuits separate, rejecting Core Capital’s request to combine them. This decision stemmed from accusations that the lead plaintiff in the ADS and other bondholders’ case, a New York University engineering professor, had “abandoned” the interests of the AT1 bondholders.
UBS has declined to comment on the ongoing litigation. Other defendants named in the lawsuits include former Credit Suisse executives, such as CEO Ulrich Koerner, Chairman Axel Lehmann, and CFO Dixit Joshi. As of now, lawyers representing these individuals have not issued any public statements.
The AT1 Bond Controversy: A Capital Cushion Turned Casualty
AT1 bonds are designed to act as a capital cushion for banks, providing a buffer against losses during periods of market turmoil. They are a type of hybrid security that combines features of both debt and equity. In the capital structure of a bank, AT1 bonds rank above common shares, meaning that bondholders are typically paid before shareholders in the event of a liquidation or bankruptcy.
However, in the case of Credit Suisse, FINMA made the unprecedented decision to write down 16 billion Swiss francs (approximately $20 billion) worth of AT1 bonds to zero. This decision was particularly controversial because it occurred while UBS was allowed to acquire Credit Suisse for $3 billion, effectively prioritizing the interests of shareholders over those of bondholders.
The AT1 bond write-down sent shockwaves through the financial markets and triggered a wave of lawsuits from disgruntled investors in the United States and Europe. Investors argued that the write-down was unfair and violated the terms of the AT1 bonds, which were supposed to rank higher than equity in the capital structure.
Judge McMahon’s Ruling: Causation and Plausibility
In seeking to dismiss Core Capital’s lawsuit, the defendants argued that the FINMA-ordered write-down, rather than any alleged fraudulent misstatements, was the direct cause of the bondholders’ losses. They contended that the write-down was an independent event that severed the causal link between the alleged fraud and the investors’ damages.
However, Judge McMahon rejected this argument, finding it plausible that disclosures of the defendants’ alleged fraud caused the value of the AT1 bonds to decline, “ultimately culminating in the eventual write-down of all Credit Suisse AT1 bonds to a value of zero.” In other words, the judge found that the alleged misstatements could have contributed to a loss of confidence in Credit Suisse, which in turn led to a decline in the value of its AT1 bonds and ultimately triggered the FINMA write-down.
This ruling is significant because it establishes a potential causal link between the alleged fraudulent misstatements and the investors’ losses. It suggests that even if the FINMA write-down was the immediate cause of the losses, the defendants could still be held liable if their misstatements contributed to the circumstances that led to the write-down.
Broader Implications for the Banking Industry and AT1 Bonds
The Credit Suisse AT1 bond controversy has raised important questions about the role and reliability of AT1 bonds as a regulatory capital instrument. The FINMA write-down has eroded investor confidence in AT1 bonds and has led to increased scrutiny of the terms and conditions of these securities.
Investor Confidence and Regulatory Certainty
The AT1 bond market relies on investor confidence and regulatory certainty. Investors need to be confident that the terms of the bonds will be respected and that regulatory actions will be predictable and transparent. The Credit Suisse AT1 bond write-down has undermined both of these factors.
Future of AT1 Bonds
The future of AT1 bonds as a regulatory capital instrument is uncertain. Some analysts believe that the Credit Suisse debacle will lead to a decline in demand for AT1 bonds, while others believe that the market will eventually recover. However, it is clear that the AT1 bond market will be subject to greater scrutiny and regulation in the future. The industry might see adjustments to the hierarchy of claims in stress scenarios or clearer communication from regulators about their intervention powers.
Impact on Bank Funding Costs
The increased uncertainty surrounding AT1 bonds could lead to higher funding costs for banks. If investors demand a higher premium to compensate for the increased risk, banks will have to pay more to issue AT1 bonds. This could put pressure on bank profitability and could make it more difficult for banks to meet their regulatory capital requirements.
Analysis and Opinion
The Credit Suisse collapse and the subsequent AT1 bond write-down represent a significant failure of regulatory oversight and risk management. The fact that FINMA prioritized shareholders over bondholders in the rescue deal has raised serious questions about the fairness and transparency of the regulatory process.
The lawsuits against UBS are an important step in holding the responsible parties accountable for their actions. If the investors can prove that Credit Suisse made false and misleading statements about its financial condition, they may be able to recover some of their losses.
However, the legal process is likely to be lengthy and complex. It is also possible that the defendants will argue that the FINMA write-down was an independent event that absolves them of liability. Ultimately, the outcome of these lawsuits will depend on the specific facts and circumstances of the case.
Regardless of the outcome of the lawsuits, the Credit Suisse AT1 bond controversy has had a lasting impact on the banking industry and the AT1 bond market. It has highlighted the importance of investor confidence, regulatory certainty, and effective risk management. It has also raised important questions about the role and reliability of AT1 bonds as a regulatory capital instrument. Regulators worldwide should review their frameworks for handling bank resolutions, especially regarding the treatment of different classes of creditors, to avoid similar crises in the future. Clearer guidelines and more transparent decision-making processes are vital for maintaining market stability and protecting investor interests.
The Credit Suisse case serves as a stark reminder of the interconnectedness of the global financial system and the potential consequences of mismanagement and regulatory failures. It is imperative that lessons are learned from this episode to prevent similar crises from occurring in the future.
