The Swiss federal government and authorities flouted rules in the forced sale of Credit Suisse by invoking emergency law, which is now being contested. The legal dispute could escalate abroad.

When UBS recently returned the state guarantee granted for its takeover of Credit Suisse, Finance Minister Karin Keller-Sutter exuded confidence. She was also blunt in addressing the complaints of thousands of investors who lost around 16 billion Swiss francs ($17 billion) of mandatory convertible AT1 Credit Suisse bonds.

The possibility of the securities being written off was regulated in the contracts, she found, and lectured the aggrieved parties with the words: «there's no business without risks.»

Unpredictable Dimension

As it turns out, it was the federal government and the Swiss Financial Market Supervisory Authority (Finma) that disregarded the text of the contract by using emergency law whose application is by no means the end of the story. Legal recourse was an option from the very beginning, and there were several conspicuous aspects to waving through the write-off.

The amount in dispute is high enough that investors could even take the matter to foreign courts. The question of the lawful use of domestic emergency law would take on international and unpredictable dimensions for Switzerland. «It is entirely possible for holders of Credit Suisse AT1 bonds to sue in the US,» Thomas Werlen, managing partner at law firm Quinn Emanuel Urquhart & Sullivan in Zurich, tells finews.asia.

Over 1,000 Bondholders

The law firm filed complaints with the Federal Administrative Court in St.Gallen in April and May to examine the legality of the write-off ordered by Finma through the emergency law. It represents over 1,000 investors holding about a third of the total nominal value of Credit Suisse's AT1 securities. The complainant has been joined by law firms from abroad.

It's not only AT1 bondholders who feel aggrieved by the merger but also Credit Suisse shareholders. Hundreds have joined forces to demand a higher takeover price from UBS, with three shareholder lawsuits filed with the Zurich Commercial Court at the beginning of the week. But it's the AT1 write-off that's attracting the most attention worldwide.

A Banana Republic?

The «Financial Times» (behind paywall) recently compared Switzerland to a banana republic. Finma's directive on the value of mandatory convertible bonds disregarded several guidelines, starting with the principle that shareholders must bleed before the bondholders' stake is touched.

According to applicable too-big-to-fail regulation for the resolution of large banks, two preconditions were needed to trigger AT1 bond converters - an undercapitalization of Credit Suisse, combined with a government financial injection. As both Keller-Sutter and Finma leaders acknowledged in the March bailout, Credit Suisse wasn't undercapitalized but had a liquidity problem. In this respect, only the state aid precondition was met.

Core Capital Never Below Regulatory Minimum

The emergency legislation that came into force on March 19 changed this. Finma was allowed to write off the AT1s even in the event of liquidity problems and state intervention, which is exactly what happened. From the point of view of investors and foreign commentators, it looks as if the federal government abruptly changed the rules of the game.

Credit Suisse's core capital ratio didn't fall below the regulatory minimum even during the whirlwind days in March. After the AT1 write-down, the ratio even shot up to over 20 percent, as the quarterly results later showed. The «SonntagsZeitung» (in German, behind paywall) recently reported that Credit Suisse management is said to have planned to repay AT1 bonds to creditors shortly before its sale to UBS. 

For the complainants, these are clear signs that Credit Suisse didn't lack equity capital during the bailout.

Outside the Permissible Framework

It can be argued the AT1 write-down primarily benefited UBS, which can report an accounting profit of around $35 billion in the first half of 2023. A report submitted by UBS to the Securities and Exchange Commission (SEC) states it was offered the write-down option on the AT1 bonds months before when it was gaming out a purchase of Credit Suisse.

According to Raphael Brunner, a commercial law specialist at Zurich law firm MME, it's precisely the nature of emergency law that it applied when the Federal Council wants to act outside its permitted scope.

The Proportionality Question

Emergency law isn't anchored in the Federal Constitution per se, but Article 185 allows the Federal Council to issue temporary ordinances and decrees in emergencies that exceed its legally enshrined powers. The text allows for a broad interpretation.

Accordingly, the question of the proportionality of emergency law is central and can be examined retrospectively, says Brunner. «Individually specific rulings by authorities can be challenged in court,» he says, and something Credit Suisse investors have already done via the Federal Administrative Court.



Reactivating AT1s

In doing so, complainants will try to take emergency law at its word, where Finma can have AT1 bonds written off, but it doesn't necessarily mean it has the authority to do so and offers a point of attack to examine the proportionality question. The constitutional principle provides that a measure must be necessary and appropriate to remedy a situation. Since Credit Suisse wasn't undercapitalized at the time of the write-off, it's a matter of dispute.

If the Federal Administrative Court upholds this argument, the AT1 bonds would have to be re-capitalized on UBS's books, and the accounting gains would probably evaporate.

Finma could argue before the Federal Administrative Court that it was pursuing a higher goal with the write-off, which was securing the stability of the Swiss, and even the global financial system.

Taxpayers Footing the Bill?

The complainants have another ace up their sleeve. They could argue the write-off constituted a material expropriation of AT1 holders. If the court agrees, the state would be liable for the damages. Given the number of investors represented in the complaint, compensation of up to four billion francs is expected, with the taxpayer stuck with the tab.

That's not all. It's to be expected the use of emergency law in Switzerland will be litigated in foreign courts. «Foreign injured parties can try to appeal to a court in their home country,» according to Brunner. The latter could declare itself competent and could then rule on whether a domestic party suffered damage due to foreign interference.

US Institutional Concerns

«The question then is whether such a foreign judgment would be enforceable in Switzerland,» Brunner points out. If a court in Saudi Arabia were to do so, the effect would be moot. But if  New York's potent Southern District Court were to approach Switzerland with such a demand, the matter would probably look different. Nine of the 13 AT1 issues were denominated in dollars of which some were sold to US institutional investors, according to reports.

Instead of a resolution, it appears the federal government and Finma are facing years of legal tug-of-war with exorbitant stakes. The next move is up to Finma where it has to face the complaint in Federal Administrative Court.