Beware of Greek lessons for AT1 bondholders

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There’s a growing sense that Switzerland probably didn’t have a rock-solid legal foundation to wipe out Credit Suisse’s $16bn of AT1s — at least on a narrow interpretation on the bond documentation clauses.

Not everyone agrees of course, but even the ECB, BoE EBA came out and pretty explicitly criticised it. That’s presumably why FINMA came out last week to stress that it also relied on an “emergency ordinance” passed by the Swiss government that weekend.

This is a classic kitchen-sink defence:

On 19 March 2023, the Federal Council enacted the Emergency Ordinance on Additional Liquidity Assistance Loans and the Granting of Federal Default Guarantees for Liquidity Assistance Loans by the Swiss National Bank to Systemically Important Banks. The Ordinance also authorises FINMA to order the borrower and the financial group to write down Additional Tier 1 capital.

Based on the contractual agreements and the Emergency Ordinance, FINMA instructed Credit Suisse to write down the AT1 bonds.

For crisis connoisseurs of a certain generation, this is a delightful/unnerving (delete according to personal preference) echo of what Greece did to its own creditors a decade ago, and a timely reminder we are all subordinated to the sovereign.

Most of the time, the jurisdiction under which a bond is issued doesn’t matter much — until it really matters. And when it does, ignore what the contract says, you are always going to be junior to political expediency. That’s life.

Back in 2012 Greece launched what was euphemistically called “private sector involvement” but in reality constituted a brutal haircut on almost €200bn of government debt (it was a 53.5 per cent reduction in nominal terms and roughly 75 per cent in net present value terms, so more of a scalping than a haircut).

To make sure that the entire (domestic) debt stack was restructured without a hitch, the Greek parliament voted to retroactively insert “collective action clauses” into all local-law government debt. These clauses bind all bondholders to anything a supermajority agrees to, thereby neutering any difficult creditors that refuse to restructure and try hold out for a better deal later on.

Now, as Allen & Overy’s Yannis Manuelides has written, this law change was theoretically done with the blessing of over half of Greece’s creditors, and the restructuring itself was voted on by over two-thirds of them.

In reality, most of them were European banks who had their arms heavily twisted by their respective governments. Various international law bonds worth €6.4bn were never restructured, and some aggrieved local-law creditors sued Greece over this legal ju-jitsu.

History doesn’t echo but it rhymes etc etc. Investors are once again on the warpath over a European government retroactively changing its laws to diddle creditors, with legal gunslingers-for-hire Quinn Emanuel leading a bondholder group that includes David Tepper of Appaloosa Management. Here’s what he told mainFT last week:

“If this is left to stand, how can you trust any debt security issued in Switzerland, or for that matter wider Europe, if governments can just change laws after the fact . . . Contracts are made to be honoured.”

The brutal truth is that the Greek situation shows that when it comes to local law bonds, the government can basically do whatever it wishes.

Greece’s bondholders also sued through the local courts and internationally under a bilateral investment treaty. They even took their case all the way to the European Court of Human Rights, arguing that their right to property had been violated.

They failed on all accounts, notes Manuelides:

The BIT claim failed on jurisdictional/procedural grounds, the challenge before the Greek courts failed because of the ‘supreme public interest’ defence and the challenge before the ECHR failed because the court held, in addition to public interest reasons, that steps taken to resolve the collective action problem are ultimately beneficial because, overall, they better preserve property.

In the Credit Suisse case, the AT1 wipeout technically happened through an executive order, rather than an act of parliament — a nuance that bondholders probably hope to exploit.

But if the Swiss Federal Assembly decide to ratify the emergency ordinance through formal legislation when it next meets it could even vote to pay creditors a bar of Toblerone and they’d still have limited chances of winning a legal case.

As Credit Suisse’s AT1 bond docs state plainly:

And further down in the T&Cs.

In theory there are limits to what a country can do within its borders, For example, there may be some constitutional checks, or myriad international treaties that set some ground rules.

In practice, being able to pass laws is the thermonuclear bomb of debt resolution, and both domestic and international courts are leery of circumscribing the power of a sovereign country. The only real constraint is that in some cases — such as with a country’s debt — being too draconian will do more harm than good because it could obliterate the domestic financial system.

Of course, this has major (albeit not new) implications for other junior bondholders around Europe, who really shouldn’t feel reassured by what officials at various central banks or governmental agencies might say about this being a uniquely Swiss thing

Does anyone really think that reelection-seeking politicians will in a major care about these statements about respecting creditor hierarchies etc if it is politically easier to stiff investors that have bought instruments explicitly designed to help recapitalise banks? If so FTAV has a (local law) Greek bond to sell them (or some commemorative merch).

That said, all the bleating about lawless, banana republic pariah state Switzerland should probably also be taken with a truckload of salt.

Over the centuries bond investors have always direly proclaimed that an issuer will be exiled from capital markets for generations if they dare to fiddle with a single coupon payment. In reality, memories are remarkably short.

Greece returned to the bond market just two years after its record-smashing debt restructuring, borrowing €3bn in 2014 at just 4.75 per cent thanks to a €20bn order book from mostly international investors. By 2021 it was able to borrow money for 30 years at below 2 per cent — and its shorter-term borrowing costs were negative.

It therefore wouldn’t be surprising to see UBS 2.0 hit the AT1 market sooner than people might think.

Further reading:
The Greek Debt Restructuring: An Autopsy (Duke Law)

Source: Financial Times

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