As the fall of Credit Suisse mobilises swathes of advisers, Legal Business asks whether the collapse will yield an influx of work for the litigation community
In March, the collapse of US-based Silicon Valley Bank (SVB) was among the biggest tremors in the banking world since 2008. However, there are weeks in which the events of decades happen, as has been the case since SVB’s demise.
First, US regional banks Signature and First Republic were shut down by regulators and rescued by competitors, respectively. Then came the truly seismic shake: after several years plagued by scandal and afflicted by loss, Credit Suisse collapsed.
‘In our view, there was no viability event and therefore no legal basis to write down the additional tier 1 bonds.’
Natasha Harrison, Pallas Partners
A deal was brokered that saw UBS acquire Credit Suisse for CHF 3bn ($3.2bn) on Sunday 19 March. UBS assumed up to CHF 5bn ($5.4bn) in losses, and the Swiss National Bank (SNB), Switzerland’s central bank, provided CHF 100bn ($108bn) in liquidity assistance.
This prompted a slew of firms from the US, the UK and Switzerland to announce mandates on the deal. Cleary Gottlieb and Sullivan & Cromwell said they were advising Credit Suisse, alongside Swiss firms Walder Wyss, which acted as lead counsel, and Homburger. Freshfields Bruckhaus Deringer acted as global transaction counsel for UBS, which was also advised by Davis Polk and Swiss firm Bär & Karrer. Latham & Watkins, meanwhile, advised Morgan Stanley, financial adviser to UBS.
Other firms involved are understood to include Fried Frank, while Linklaters has long had links with both banks.
The buyout was coordinated by a ‘trinity’ of Swiss institutions, including the SNB, the Financial Market Supervisory Authority (FINMA) and the Federal Department of Finance (FDF). The response was rapid, ad hoc and unprecedented. Credit Suisse shareholders were compensated with one UBS share for every 22.48 Credit Suisse shares held – equivalent to CHF 0.76 per share, for a total of CHF 3bn.
Crucially, holders of additional tier 1 bonds (AT1s) received nothing, and FINMA wrote down the value of Credit Suisse’s CHF 16bn ($17bn) worth of AT1s to zero.
AT1 bondholders reeled, and already on Monday 20 March, Quinn Emanuel Urquhart & Sullivan issued a statement announcing that it was in discussion with AT1 bondholders ‘about the possible legal actions that may be available to them’. City disputes boutique Pallas Partners released its own statement the next day, after founder and managing partner Natasha Harrison (pictured) posted on LinkedIn inviting contact from Credit Suisse AT1 bondholders impacted by the deal.
Quinn announced on Thursday 30 March that a ‘multi-disciplinary team’ from Switzerland, the UK and the US had been instructed by a group of bondholders representing a ‘significant percentage of the total notional value of the AT1 instruments issued by Credit Suisse’.
Write-down, or wrong?
Any litigation will rest on how the AT1s were written down.
AT1s, also known as contingent convertible bonds or CoCos, were created in the wake of the 2008 financial crash. In the hierarchy of capital held by European banks, they sit just below common equity tier 1 capital (CET1), which consists largely of common stock. Fundamental to AT1s’ design is that, in a time of crisis, they can be converted into common stock or temporarily or permanently written down.
The terms under which different AT1s can be converted or written down are specified in the prospectuses that purchasers view before buying them. The prospectuses of Credit Suisse’s AT1s provide for a write-down to zero if regulators deem that a ‘viability event’ has occurred. Two types of viability event are outlined. First, if Credit Suisse’s CET1 ratio falls below 7%. Second, if regulators deem a write-down essential to prevent Credit Suisse’s falling into insolvency.
‘Both conditions are very closely tied to the solvency and capital adequacy of the bank’, said Harrison. ‘They are not linked to liquidity, and the wording on that is quite clear. In our view, there was no viability event and therefore no legal basis to write down the bonds.’
The powers under which FINMA ultimately wrote down the AT1s came from two emergency ordinances adopted by the Swiss Federal Council on 16 and 19 March. The 16 March ordinance was relatively uncontroversial, and focused on enabling the SNB to provide liquidity assistance to support UBS’s acquisition of Credit Suisse.
However, article 5a of the 19 March ordinance contained the following provision: ‘At the time of the credit approval […] FINMA may order the borrower and the financial group to write down additional Tier 1 capital.’
In a 23 March statement, FINMA argued that it wrote down the AT1s ‘based on the contractual agreements and the Emergency Ordinance [of 19 March].’
Harrison highlighted this point: ‘Switzerland wasn’t quite clear upon which basis it was going to write down the bonds. And, in particular, it didn’t seem to rely on the terms of the notes when it passed the ordinances. But today it has said that it is relying on the second limb of the definition of “viability event” under the terms of the note.’
Litigators will turn their attention to the terms outlined in the prospectus. Credit Suisse’s CET1 ratio did not fall below 7% before the AT1s were written down. So the question is whether FINMA can argue that a write-down was necessary to prevent Credit Suisse’s insolvency. In this context, the payout to shareholders becomes critical.
When a bank goes insolvent, there is a standard hierarchy of claims to compensation. In this hierarchy, AT1 bondholders would usually rank above common stockholders, and could reasonably expect to be paid first.
‘What seems particularly egregious’, said Harrison, ‘is that, as a consequence of wrongfully writing down the notes, the claims hierarchy was also upended.’
In the wake of the write-down, central banks from the Monetary Authority of Singapore (MAS) to the European Central Bank (ECB) and the Bank of England (BoE) were quick to assert that they would respect the hierarchy of claims in similar proceedings in their jurisdictions.
‘The UK’s bank resolution framework has a clear statutory order in which shareholders and creditors would bear losses in a resolution or insolvency scenario’, the BoE said in its 20 March statement.
‘AT1 instruments rank ahead of CET1 and behind T2 in the hierarchy. Holders of such instruments should expect to be exposed to losses in resolution or insolvency in the order of their position in this hierarchy.’
For Harrison, the raft of statements from central banks around the world ‘just demonstrates how much of an outlier Switzerland is’.
For Hogan Lovells’ global financial institutions and insurance sector head Sharon Lewis, however, the issue is more nuanced. ‘You do not expect to see bondholders being taken out and written off before shareholders’, she explains. ‘It’s sort of the ABC of what you learn.’
She continues: ‘But, if you take a look at the prospectuses of these bonds, they don’t say that a write-off is conditioned on the shares being written off. Contractually, that’s not what is written. I’m not a Swiss law expert, and it’ll be a question of Swiss law. But, if I were to rely on a hierarchy of payments, I personally would expect one to appear in my contract.’
Still, the issue is far from settled, and FINMA’s position is further complicated by what Harrison referred to as ‘misstatements and misrepresentations’ concerning Credit Suisse’s viability.
‘In the weeks building up to the wipe out’, she said, ‘Credit Suisse made all sorts of representations about its financial health. In particular, on 14 March, it prepared a fixed-income investor presentation, and demonstrated no concerns about its viability.
‘We say that by making those misstatements and misrepresentations, Credit Suisse and the regulators have caused bondholders to suffer loss, either because by reliance on those misstatements they decided to continue to hold their notes, or because on the basis of those statements they bought new notes.’
This may open the way for litigation under securities fraud laws in jurisdictions including England and federal and state jurisdictions in the US. But the paths along which such claims could proceed are unclear, and the Swiss courts are likely to fight hard to retain jurisdiction.
Far from straightforward
Litigators may also bring claims concerning the lawfulness of both the emergency ordinances that granted FINMA the power to write down the bonds and FINMA’s exercise of that power.
In Harrison’s words: ‘Whilst the legislation and the ordinances themselves might be unlawful – and there are certainly powerful arguments that the ordinances were unlawful – the delegation of powers to FINMA to write down the AT1s must be challenged as well.’
Both Quinn and Pallas are exploring the possibility of pursuing claims against the Swiss state under bilateral investment treaties (BITs). But the availability of such claims would turn on both an individual foreign investor’s factual circumstances and the terms of the specific BIT under which the investor is protected.
Moreover, such claims would need to establish that the Swiss state had acted unlawfully. In the view of Stuart Dutson, international head of arbitration at Simmons & Simmons, this will be a high bar to clear. ‘It’s going to be extraordinarily difficult to bring claims under bilateral investment treaties. You can’t sue UBS and Credit Suisse under a bilateral investment treaty. You have to sue Switzerland.
‘I understand that AT1 investors in particular feel aggrieved. But I think it’s going to be a very difficult win, if they go for that.’
Both firms were keen to stress that they are at the very earliest stages of formulating their claims, and the question of where claims will be brought remains very much open.
‘These claims will not be straightforward’, said Keith Thomas, head of securities litigation at Stewarts. ‘There are contractual and legal hurdles to overcome, and it is likely that they will be heavily contested.
‘As ever with cross-border matters, you can expect the parties to play a tactical game and seek to litigate in the jurisdictions likely to produce the most favourable result for them.’
Of course, the prospective defendants will seek to do the same.
Comfort or uncertainty?
Some investors have been cutting in their criticism of the Swiss state’s actions. But, as with HSBC’s rescue of SVBUK, UBS’s acquisition of Credit Suisse does seem to have prevented Credit Suisse’s collapse from escalating into an industry-wide crisis. Stock markets remain unsettled, but there has been no widespread plummet, despite concerns around Deutsche Bank. In a signal of confidence, both the US Federal Reserve System and the BoE again raised interest rates on 22 and 23 March, respectively.
‘It has brought a certain degree of comfort to the market’, said Lewis. ‘Though of course there remains a fair amount of volatility and uncertainty.’
‘These claims will not be straightforward. There are contractual and legal hurdles to overcome, and it is likely that they will be heavily contested.’
Keith Thomas, Stewarts
It is perhaps too early to determine whether the Swiss state’s solution can be called a success. Reactions in Switzerland have been mixed: polls show widespread public disapproval of the takeover, and opposition politicians have questioned the emergency ordinances. On Sunday 2 April, the federal prosecutor opened an investigation into the acquisition. ‘The Office of the Attorney General wants to proactively fulfil its mandate and responsibility to contribute to a clean Swiss financial centre’, the prosecutor said in a statement.
The outcome and process of the investigation will be closely watched by litigators and potential claimants. But the measure of success will likely be found in the health of the banking sector. And if a wider crisis is averted, litigators may struggle to find sympathetic ears for arguments that the Swiss state’s actions were unlawful.
‘The prevailing view is that speed was a priority’, Lewis explained. ‘There was a lot of market speculation, and if a deal had not been done over the weekend, what would have happened on Monday morning? There could have been a run on the bank. And if there had been a run, where would it have ended? That would have been first and foremost in regulators’ minds.’
And, as Thomas noted, regulators would not have been unaware of the risks. ‘If, as looks increasingly apparent, the structure of the Credit Suisse takeover contained an element of political expediency to get the deal done with less attention paid to the black-letter provisions of the bonds, then it is likely that those involved were aware of that and took a view that the risk of litigation and the potential for having to pay damages further down the line were worth it when weighed against what might have happened had the deal not been done.’
We are in the midst of the first real test of the post-2008 regulatory regime. And it is difficult at this stage to assess how that regime has performed. Both SVB and Credit Suisse had unique problems. But lawyers, regulators, bankers and investors are watching carefully for signs of contagion.
With this in mind, the process and eventual outcome of litigation is all the more important – to investors’ willingness to invest, to perceptions of the Swiss state, and to the worldwide banking system.