The CoCo Pops lawsuit revisited

Jay Newman was a senior portfolio manager at Elliott Management. He has no financial position in the CS AT1s.

When a legal claim against a well-heeled defendant trades in single digits, it’s often worth taking a second look.

That goes double for claims arising from the precipitous and suspicious cancellation of Credit Suisse’s additional tier 1 (AT1) bonds. The AT1 story may seem like yesterday’s news: the international press and Alphaville have reported on it extensively. There’s a widely held view that Swiss regulators are paragons of integrity and must have had the authority to order the cancellation of this tier of debt and force a merger between CS and UBS, and that the local-law advantage will stymie aggrieved creditors.

Not so fast.

What makes the AT1s worth a hard look is a rare confluence of factors: proceedings before Switzerland’s Federal Administrative Court (FAC), stonewalling by the Swiss Financial Market Supervisory Authority (FINMA) in the FAC proceeding, an investigation by the Swiss parliament, a ham-fisted government cover-up, and the very real possibility — I’d say high likelihood — that additional legal actions will be brought in common law jurisdictions before long. 

The fundamental question is whether, when it comes to local law bonds, a sovereign can get away with doing what it pleases. Surprisingly, this question bedevils Switzerland — not just developing countries. Argentina and Greece have repeatedly schooled investors in what happens when a sovereign refuses to play it straight. The Swiss government is offering a similar lesson.

Without rehashing too much of the AT1 story, some stage-setting is in order. 

First, perhaps foremost, the senior management of UBS long coveted CS. As far back as 2016, the bank embarked on “Project Signal,” a secret plan to absorb its rival. The events of 2023 provided an opening. Playing on the nervousness — perhaps, ultimately, the fecklessness — of Swiss regulators, UBS gobbled CS on the cheap.

Second, CS was a friendless mess. In the span of a few years, its CEO resigned in the wake of a scandal involving spying on a former executive; the bank lost $6bn — and whatever credibility it had as a risk manager — as a result of the failure of investment funds Greensill and Archegos; and it was fined and censured by US and UK authorities for bribery, wire fraud, and money laundering in relation to $1.2bn of secret loans to Mozambique. The coup de grâce was the rumour of its impending failure: that caused clients to pull over $120 billion in the last quarter of 2022. 

When the Saudi National Bank, its largest shareholder, declined to provide support earlier this year, counterparties curtailed credit limits, and Swiss regulators seem to have decided that they needed to do something.

But what? 

There’s no question that — under certain circumstances — FINMA and the Swiss National Bank (SNB) have the authority to cancel the AT1s. But that prerogative only kicks in if a Swiss bank experiences a “viability” event: defined as the bank being undercapitalised. Even then, a viability event, in and of itself, is insufficient. Only if a bank is undercapitalised and Swiss authorities provide financing to support the capitalisation of the bank can the AT1s be cancelled. Financing provided merely to enhance liquidity doesn’t count.

Here’s the rub: FINMA, the SNB, and CS said before the deal and at press conferences after the fact that CS was not undercapitalised. It had a liquidity problem. The prospectuses and bond documents state clearly that liquidity issues do not trigger writedowns. Swiss authorities did offer emergency financing to CS — specifically to provide additional liquidity.

Only after directing the writedown (over the objections of CS) did the Swiss authorities recognise that they had a little problem. Having failed to follow its own rules — which should have required them to zero out CS equity and the tier 2 debt as well — FINMA moved into cover-up mode.

The Smoking Gun: The Swiss Federal Council, essentially the executive branch, retroactively introduced new rules (Articles 5a, 10a, and 14a of the Emergency Ordinance of 16 March 2023) adding emergency liquidity financing to the list of circumstances under which FINMA could authorise a write down.

Procedurally, roughly 1,000 members of a so-called joint plaintiffs community (represented by Quinn Emanuel, Pallas Partners, and several other firms) have asked the FAC either to reinstate the AT1s or find damages. Reinstatement would add about $17bn of AT1 debt (plus accrued interest) to the UBS balance sheet. A successful damages claim, based on FINMA having violated the Swiss constitution by imposing a regulatory action that deprived people of their property, would, presumably, be borne by Swiss taxpayers.

Technically, this isn’t a lawsuit against FINMA, but a complaint against the legality of FINMA’s order — which FINMA is making every effort to keep secret — even to the point of trying to refuse to produce documents in the FAC case on the basis that they are “top secret.” The FAC decides all matters relating to the Federal Administration. It’s Switzerland’s second highest court, second only to the Supreme Court.

But the plot thickens. 

The FAC may decide to bide its time while a newly formed parliamentary commission (PUK) investigates the government’s role in the CS-UBS transaction. This PUK is only the fifth commission ever formed to investigate the Swiss executive branch (the last one was empanelled in 1995). That might take a year or more. So, even though the court has begun its investigation — and ordered the government to cough up documents — the case might drag on a bit.

Make no mistake: the PUK inquiry is a big deal. In theory, the PUK has full access to the files of the Confederation, FINMA, and the SNB, and can subpoena people, including representatives of UBS and CS.

Across the Swiss political spectrum, few supported the backroom dealings and shotgun marriage of UBS and CS. The left hated it because of job losses — some 35,000 and counting. The right hated it because they warned about the consequences of internationalising Swiss banks in the first place. The centre detests the perception that Switzerland is a hapless banana republic: failing to respect its own laws, retroactively adopting self-serving rules. It’s not as if the Swiss government wasn’t warned: its parliament voted not to approve the merger.

Of course, the PUK inquiry has its own quirks. Files relating to the investigation will be embargoed for 50 years, rather than the usual 30 — a degree of defensiveness and secrecy that troubles some Swiss historians. Apparently, full transparency either to the court or to the public risks national security. 

Coming attractions: Given the scale of the losses, the lack of transparency, and the arrogance and audacity of the cover-up, it seems inevitable that litigation will proliferate, spilling over into common law jurisdictions (the US the UK) where disclosure and discovery can force the Swiss authorities to open their files. When that happens, the gloves will be off. Legal actions won’t be limited to polite administrative review of FINMA’s March 19 order. We’ll see full blown lawsuits directed at FINMA, the Swiss National Bank, and UBS. For students of sovereign debt, there will be plenty of theatre — and lots of issues to sort through, like jurisdiction, sovereign immunity, and the like.

Litigation has a way of unravelling tangled webs, revealing greater truths. From the look of it, unless the Swiss government starts writing some big checks, the various lawsuits and investigations already under way — and those likely to be brought by bondholders, shareholders, and former employees — will offer a window into precisely how the Swiss government works, and whether Switzerland is a banana republic or a paragon of probity and a safe place to invest.