Investors in Crédit Suisse AT1 bonds who suffered financially during its merger with UBS earlier this year have options to help them recover their losses.
On 19 March 2023, UBS agreed to acquire Crédit Suisse following a series of scandals and heavy financial losses at the investment bank. To secure the merger between UBS and Crédit Suisse, the Swiss government passed an ordinance allowing the Swiss Financial Market Supervisory Authority (FINMA) to ‘write down’ the additional tier one (AT1) bonds issued by Crédit Suisse.
Subsequently, FINMA exercised its power by writing down the Crédit Suisse AT1 bonds, amounting in total to a nominal value of $17.9 billion, to zero. These actions bypassed the standard six-week consultation period.
What are AT1 bonds?
AT1 bonds were introduced in many countries after the 2008 global financial crisis in order to increase bank capital levels. The bonds are a form of high-risk debt that can be converted into equity if the capital ratio of the issuing bank falls below a stated level. In corporate finance hierarchy, AT1 bonds rank below other bonds, which in turn rank below deposits, but above equity capital held by shareholders. This hierarchy is reflected in the information document issued by Crédit Suisse in relation to its AT1 bonds.
This customary and contractual hierarchy was not respected with the Crédit Suisse restructuring. Crédit Suisse shareholders retained value amounting to around $3.4bn while the investment of AT1 bondholders was entirely written off. Some AT1 bondholders have filed proceedings in Switzerland against FINMA in relation to this decision. Investment arbitration may be an additional or alternative option for AT1 bondholders.
What is investor-state arbitration?
Investor-state arbitration, or investor-state dispute settlement (ISDS), is a method of dispute resolution based on international agreements. These can be bilateral investment treaties (BITs), multilateral investment treaties (MITs) or investment provisions of free trade agreements. These treaties set out minimum standards of treatment which host governments must apply to investments owned by investors from other contracting states.
If an investor from one contracting state considers that the government of another contracting state has not respected these minimum standards, it can initiate an investment arbitration claim against the host government. These claims are submitted to neutral third-party arbitration which results in a binding and enforceable decision.
Are bonds investments?
The majority of BITs contain a definition of “investor” and “investment”. To have the right to bring a claim, an investor must establish that it is an investor of a state which is party to an investment treaty with Switzerland and that the asset to which its claim relates constitutes an investment as defined in the relevant treaty.
Many, though not all, investment treaties contain a wide definition of “investment”. For example, the Switzerland-Qatar BIT describes an investment as “every kind of asset”. Similarly, the Switzerland-Singapore BIT states that “investment” comprises “every kind of asset” and of particular relevance “stock shares and securities and other interests in companies”.
Some investment arbitration tribunals have applied this wide definition literally, while others have read implied restrictions into the concept. In its decision in Salini v Morocco, an International Centre for Settlement of Investment Disputes (ICSID) tribunal established a number of criteria traditionally referred to as the ‘Salini criteria’. These include:
- a contribution of money or assets by the investor;
- that the investment be subject to a certain level of risk;
- that the investment be for a certain duration or length of time; and
- that the investment contributes to the economy of the host State.
Several investor-state cases have considered whether bonds are “investments”. In relation to sovereign bonds, for example, a subsequent ICSID tribunal found that the “risk” element of the Salini criteria had not been met, meaning that sovereign bonds were not considered “investments”. Conversely, however, in a dispute involving the Argentine Republic, another ICSID tribunal stated that the broad definition of investment under the applicable BIT meant that sovereign bonds were investments.
Strategic considerations for investors
There may be at least two options available to AT1 bondholders:
- legal action before Swiss courts in relation to FINMA’s decision to write down their AT1 bonds; and/or
- investment arbitration against Switzerland under an applicable investment treaty.
These options are not necessarily exclusive, though they may be if the relevant investment treaty contains a “fork-in-the-road” clause, whereby an investor which has made a claim before the host country’s courts may be barred from later making the same claim in investment arbitration.
However, investors should in any event consider both options carefully before embarking on either, and in particular should consider whether taking either option could preclude taking the other at a later date. Investors may also wish to consider how to keep both options open by, for example, avoiding inconsistent case strategies and arguments. Investors considering their options in relation to AT1 bonds will likely wish to consider the differences between Swiss court proceedings and ISDS.
First, any claims before Swiss courts on the basis of FINMA’s decision will likely be evaluated in accordance with Swiss law. FINMA’s decision may or may not be considered justifiable by domestic Swiss legal standards. An ISDS claim against Switzerland, by contrast, would be determined under international law, with domestic law playing a subordinate role.
This would likely be beneficial for AT1 bondholders, as international investment law offers different – and often broader – rights and protections to investors, including guarantees of fair and equitable treatment and of prompt, adequate and effective compensation in case of expropriation, as compared with those available under most domestic legal systems.
Naturally, claims before Swiss courts will be assigned for adjudication to one or more Swiss judges over whose selection bondholder claimants will have no influence. By contrast, investor-state arbitration claims are judged by an international arbitral tribunal normally consisting of three arbitrators. The claimant investor has, like the respondent state, the right to select one arbitrator, subject to requirements of independence and impartiality, and a voice in the selection of the third, or presiding, arbitrator.
Moreover, claims under Swiss law may be subject to a limitation period. This is generally not the case for investment arbitration claims. In this regard, timing is a significant issue. Some AT1 bondholders are already preparing to exercise their investment arbitration options while others are adopting a wait-and-see approach.
Both have advantages; among other considerations, by awaiting developments, subsequent investors will be able to learn from any information they can obtain regarding the strategies and arguments deployed by prior investors, and by Switzerland in response, although of course the same will be true for Switzerland. Of course, AT1 bondholders which initiate their claims early stand a better chance of an early recovery, either in the form of a final arbitral award or through a settlement with Switzerland.
Swiss courts and international investment tribunals may also adopt a different approach to valuation of losses. Although there have been recent calls for change, international investment law usually attempts to value lost assets at their full pre-breach economic value, placing the investor, as closely as possible, in the position which it would have had if no breach had taken place.
The precise date of asset valuation is also important: in case of expropriation, treaties usually provide that assets should be valued at the date immediately prior to the State’s decision to expropriate being made or becoming publicly known. The value of Crédit Suisse’s AT1 bonds varied significantly during the weeks prior to FINMA’s decision and so this aspect will require careful attention.
Co-written by Xiao Hui Eng, Aman Tandon, and Kyle Melville of Pinsent Masons.
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