Here, first, is what the Swiss financial authorities got right. They recognised that outsiders’ confidence in Credit Suisse was shot. They saw that the flight of depositors, which was reported to have reached €10bn (£8.7bn) a day last week, would get worse. They knew that only a full takeover, as opposed to complicated financial surgery, could withstand another onslaught by markets.
That being so, the buyer had to be UBS, a credible institution whose management could be told to think of its patriotic duty and do the deal over a weekend. And the terms, at face value, look generous to UBS, so the risk of creating a bigger banking whirlpool is lessened. The danger is not eliminated but plenty of grown-up banking voices judged that the acquirer is getting a bargain (a better one, for example, than the non-bargain that was Lloyds TSB’s rescue of Halifax Bank of Scotland in 2008).
As an exercise in pragmatic resolution, then, it could have been worse. The pretence that the sale is wholly a private sector solution is risible because UBS was strong-armed into the deal (as the bank’s statement made clear, more or less) and has been given a loss guarantee of up to 9bn Swiss francs (£7.9bn) plus a 100bn franc liquidity line. But it’s not a desperate nationalisation, which would have terrified investors everywhere.
Then, though, one comes to the confusing decision to wipe out holders of 16bn Swiss francs-worth of AT1, or alternative tier 1, bonds in their entirety while allowing Credit Suisse’s shareholders to escape with a payout of 3bn Swiss francs (£2.6bn) in the form of UBS shares. One could take the view that shareholders are getting only a tiny sum of less than a franc a share but, by rights, the figure ought to be zero. We thought the post-2008 rules were crystal clear: shareholders get eliminated before anybody else gets hit.
Why did the Swiss authorities ignore this supposedly sacred principle? They didn’t explain, which makes matters worse. Was it an attempt to spare complete humiliation for Credit Suisse’s management, which would be a perverse priority? Was it a last fling at promoting the “agreed merger” line, which nobody believes? Or was it just the fact in Switzerland, at least, the small print of the bonds seems to allow regulators to do as they please, so why not bow to what, one suspects, was a key demand from UBS’s boardroom?
Whatever the truth, for the sake of 3bn Swiss francs – a piddling sum – the Swiss authorities opened a can of worms, as other regulators recognised immediately. The European Central Bank and the Bank of England, while welcoming the “comprehensive” Swiss action, separately stated that they haven’t gone soft on whacking shareholders when appropriate. “Common equity instruments are the first ones to absorb losses, and only after their full use would additional tier 1 be required to be written down,” said the ECB.
Nobody should have fooled themselves that ATI bonds are risk-free, of course. These so-called “contingent capital” notes are designed to take losses in a crisis and ease a bank’s debt burden. If shareholders had also got zero, there could be no grounds for complaint, legal or moral. The problem is solely the ripping-up of the hierarchy of financial pain.
The Swiss approach – potentially – could have big consequences. If AT1 bonds are perceived to be riskier than previously assumed, banks will have to offer higher interest rates to issue them, which would raise their funding costs with knock-on effects over time on the price of credit in the real world. Since there are reckoned to be $275bn (£224bn) of these instruments in issue around the world, it is not a small market to mess with – thus other regulators’ scramble to say nothing has changed in their back yards.
The mini-drama with AT1 bonds could go one of two ways. Bondholders in non-Swiss banks could shrug and say it’s just the Swiss being idiosyncratically Swiss, which is what the Threadneedle Street and ECB are hoping. Alternatively, a financial instrument designed to absorb shocks could start creating a few, which won’t help wider confidence in the banking system one bit.
In better news, tension in the banking world eased as central banks offered massive quantities of dollar liquidity – offers that, encouragingly, have barely been taken up so far. But the long-term impact of the ATI affair is the big unknown. The shuffle helped to get the sale of Credit Suisse over the line but there was no possible logic in giving shareholders anything. Investors are right to be baffled.
