The transaction between Credit Suisse and UBS has been in the news a lot lately. But what exactly happened? And what has been the role of the legislative resolution in this? In this article, I will explain the European legal framework for the resolution of systemically important banks, and then discuss the situation in Switzerland. I describe how the M&A transaction took place and assess the possible consequences for legal certainty. This article is a concise legal elaboration of the Credit Suisse rescue.
THE RESOLUTION FRAMEWORK
After the credit crisis of 2007/2008, a lot of new legislation was created to ensure that financial institutions are less likely to be put at risk and can be rescued if things go wrong. This is not so much about saving the financial institution itself, but about the critical services that this institution provides (such as payment services by banks).
If a bank in the Netherlands fails, the main rule is that it will go bankrupt, but in some cases it is in the public interest (for customers, other financial institutions and our economy) that a bank is resolved in a controlled manner. This prevents the sudden loss of many critical services, resulting in (again) a heavy impact on the economy. Especially if the institution is highly intertwined in the European or global economy. It is therefore said that the institutions are 'too big to fail'.
The legislation that deals with the controlled resolution of these types of systemically important financial institutions is also known as 'resolution' legislation. It is the task of the resolution authority to enforce this legislation and to intervene if things threaten to go wrong. This task is also known as the 'resolution task'.
Resolution legislation differs from ordinary bankruptcy law. For example, the resolution authority has many far-reaching powers, such as the conversion or depreciation of capital, which can be used to protect the aforementioned public interest. The resolution authority also takes the decision to resolve a financial institution in resolution. This does not require a court ruling.
In the Netherlands, the central bank (De Nederlandsche Bank – 'DNB') is also the resolution authority. In Switzerland, the central bank (the Swiss National Bank – 'SNB') and the resolution authority (the Swiss Financial Market Supervisory Authority – 'FINMA') are separate.
An important starting point of the resolution on legislation for banks in Europe is the BRRD I and II.[1] With these European directives, an attempt has been made to harmonise the resolution of banks within the EU. These directives will then have to be implemented by Member States in national legislation. In the Netherlands, this has been done by means of two implementing laws that have amended, among other things, the Financial Supervision Act.[2] However, Switzerland is not a member of the European Union and is therefore not bound by the BRRD I and II. Nevertheless, Switzerland has chosen to introduce a resolution regime for banks in its national legislation that is very much in line with the BRRD.[3]
The process of resolution begins in both Europe and Switzerland with a decision taken by the resolution authority to wind up the institution.[4] This decision stipulates that the financial institution in question meets the conditions for resolution and will therefore not be settled in a lawful manner in bankruptcy proceedings. Instead, the resolution authority will intervene and take certain resolution measures. There are many different measures that a resolution authority can take, including writing off capital instruments/ownership instruments and effecting a takeover. The purpose of this is to ensure the stability of the financial market and also to offer a better (or at least equivalent) result for creditors compared to a regular bankruptcy process (the so-called 'no creditor worse off' principle).[5]
CREDIT SUISSE RESOLUTION PLANNING
An important part of resolution is preparation. After all, you want to be able to intervene quickly if things go wrong. For systemically important banks, plans are therefore being drawn up that describe what measures will be needed in the event of a financial stress scenario to stabilise the bank and ensure that its critical services can continue. This preparation is also called 'resolution planning' and consists of, among other things, a recovery plan and a resolution plan.[6]
The recovery plan elaborates on how the institution could stabilize itself in the event of a financial stress scenario. These are therefore measures that the institution could take itself and are intended for the period before the deployment of resolution measures. Recovery plans for systemically important banks in both the EU and Switzerland are drawn up by the institution itself and then approved by the resolution authority.[7]
The resolution plan sets out how best to wind up the institution if it fails or is likely to fail. This plan is therefore about the execution of the resolution task and is therefore drawn up by the resolution authority. Resolution plans for systemically important banks in Europe are drawn up by the Single Resolution Board ('SRB') and the national resolution authorities.[8] In Switzerland, it is drawn up by FINMA.[9]
According to the FINMA, Credit Suisse's (hereafter 'CS') resolution schedule was well on track at the beginning of 2022. CS's recovery plan had been approved for a number of years and steps were taken every year to ensure that CS could be handled in a more controlled manner, should it come to that.[10]
However, following this statement by FINMA, CS's financial position has changed significantly. More and more assets flowed out of the bank and it also made more and more losses.[11] At the start of 2023, CS's share price was about 69% lower than a year earlier.
When Silicon Valley Bank collapsed in March 2023, the FINMA and the SNB jointly published a statement on March 15, 2023 indicating that there is no immediate risk of contagion for Swiss institutions as a result of the turmoil in the U.S. banking market.[12] They referred to the minimum capital requirements for banks in Switzerland. The FINMA even explicitly named CS and indicated that CS met these capital requirements. On 16 March 2023, CS also indicated that it wanted to (preventively) borrow CHF 50 billion from the SNB to strengthen its liquidity.[13]
When CS, as a systemically important bank, is in dire financial straits, the rule is that the recovery plan that has been drawn up is first examined. This should allow CS to take measures to recover financially (even before resolution).[14] Although it is not immediately clear from the outside whether the CHF 50 billion loan that CS wanted to take out was a measure from the recovery plan, it did not come to that in the end. Three days later (March 19, 2023), FINMA announced that it had approved the merger of CS and UBS.[15]
As usual with financial stress scenarios of banks, a lot has happened in a short period of time. In the case of CS, it makes sense to use the resolution plan of the FINMA (the Abwicklungsplan). After all, that is what the resolution legislation is written for. This is because capital instruments (AT1 bonds) were written off from CS and ownership instruments (shares) were transferred at a reduced value. However, FINMA never took the decision to make a resolution. Such a decision must also be made public, and that has never happened.[16]
Although an extensive resolution framework has been established and years have been prepared for it, the entire resolution framework has not been used in the end. Perhaps it's a shame about all that work, but according to certain sources within UBS, resolution would have been a disaster for the (global) financial system anyway.[17] So what did happen?
EMERGENCY LEGISLATION
So there has been no resolution. Instead, the Swiss government has taken a series of exceptional measures to rescue CS out of resolution and get it out of its tailspin.
On 19 March 2023, the Swiss Federal Council published a regulation, which entered into force retroactively from 16 March 2023, for the granting of liquidity support and guarantees to systemically important banks (the 'Liquidity Assistance Regulation').[18] This regulation was subsequently amended again immediately (with effect from 19 March 2023) to provide for the special situation of CS (the 'Amended Liquidity Support Regulation').[19] The two regulations were also used immediately after publication. The Swiss Federal Council announced that they support the takeover by UBS and that the federal government (on the basis of the Amended Liquidity Support Regulation) provides a guarantee for additional liquidity support for CS from the SNB.[20] The Swiss Federal Council indicated that these regulations are emergency laws, created under the Swiss Constitution to protect financial stability and the Swiss economy.[21]
In the following sections, I will first discuss the M&A transaction between UBS and CS, in order to get an idea of the effects of this change in the law. Finally, I will discuss its specifics, such as the depreciation of the AT1 capital, and reflect on the impact that these emergency laws may have on legal certainty.
THE TRANSACTION
Although not all the details of the transaction are yet known (not even for the parties to the transaction), it does not appear to be an acquisition, but a merger (more specifically, an Absorptionsfusion).[22] This is because no public offer has been made for the shares in CS. Instead, a merger agreement has been entered into under which every 22.48 CS shares will be exchanged for one share in UBS.[23]
To my knowledge, the exact entities involved have not yet been publicly confirmed, but the target company is most likely Credit Suisse Group AG, the parent company of the CS group. It is also likely that the acquiring entity will be UBS Group AG, the parent company of the UBS group.
This will mean that all assets and liabilities of Credit Suisse Group AG will automatically transfer to UBS Group AG under the Swiss Merger Act (Fusionsgesetz) upon entry into force of the merger and that Credit Suisse Group AG will cease to exist.[24] As a result, Credit Suisse AG, the group's intermediate holding company and currently subsidiary of Credit Suisse Group AG, would become a direct subsidiary of UBS Group AG.
What is confusing is the statement from the Swiss government in which it spoke of a 'takeover' of CS by UBS.[25] This seems to suggest that there is an acquisition rather than a merger. The UBS website also refers to an 'acquisition' instead of a 'merger', but in the presentation that UBS gave about this, it was clearly stated that it was an 'exchange' of CS shares in UBS shares.[26]
So, although a merger agreement (Fusionsvertrags) has already been concluded, it has not yet been completed. Under Swiss law, a merger also requires shareholder approval from both the acquired entity and the acquiring entity.[27] In this case, however, the Swiss Federal Council used its emergency powers (through the Amended Liquidity Support Regulation) and shareholder approval was not required.[28] In accordance with these new (temporary) regulations, a merger report (Mergers Notice) and an audit of the merger agreement and the balance sheets of the entities involved are also no longer required.[29]
These last-minute changes to the law have caused a lot of commotion, but who initiated this rescue? The Swiss Federal Council describes the transaction in such a way that it appears to have been proposed by UBS and they "welcome" it, but UBS has indicated that regulators around the world have urged them to consider a takeover of CS.[30] Also according to certain internal sources within CS, there would have been a lot of pressure from the government, to the point that it can actually be called an order.[31] However, the reluctance from the CS board is understandable. While this may be a favorable deal for UBS, it is the shareholders of CS, among others, who have had to give up for it. They have therefore put up a lot of resistance to a deal with UBS because of the unfavorable exchange ratio. They would even have proposed USD 5 billion as an investment, which would not have been approved by the Swiss government.[32] The creditors of the AT1 bonds are not happy either. Their claim was written off in full by CS as a result of an order from FINMA under the Amended Liquidity Regulation.[33]
In the next section, I will elaborate on this write-off and on the intervention of the Swiss government as a whole. In doing so, I look not only at the interests of creditors and shareholders, but also at the consequences for legal certainty and resolution.
DEPRECIATION OF AT1 CAPITAL
It is common for a shareholder in bankruptcy to receive nothing from the estate because they are generally the lowest in rank within the bankruptcy process. In the Netherlands, distributions are only made to shareholders (other than on the basis of a shareholder loan or other right of claim) in the event of a liquidation surplus after the bankruptcy proceedings.[34] The order of precedence in bankruptcy is also used within the European resolution regime when the resolution authority decides to write off claims (a so-called 'bail-in').[35] The reference point in resolution is the bankruptcy scenario. It should not be the case that, as a result of the application of resolution, creditors receive less than they would have received under a regular bankruptcy process (the 'no creditor worse off' principle).[36] Moreover, the European resolution regime for banks explicitly states that shareholders will bear the first losses in the application of resolution instruments.[37] This rule also applies to the resolution of Swiss banks.[38]
The idea behind this seems to me to be that the shareholder receives the profits from the company when things are going well, but also suffers the losses when things are going badly. This also creates trust towards third parties who want to do business with the company. People are very critical of it if this relationship is distorted and shareholders are given a higher rank, for example by providing shareholder loans with security.[39] If shareholders were to be paid with priority, a skewed ratio would arise. The shareholders receive the profits, but do not (entirely) suffer the losses.
It is therefore very unusual that the merger of CS decided to write off no less than CHF 16 billion in AT1 bonds (tier 1 loans), while the shareholders received a total of about CHF 3 billion (CHF 0.76 per share) in value in UBS shares. It had been expected (and perhaps should have expected) that the shareholders would first be written off in full before the creditors under the AT1 bonds would be written off. Due to the rapid pace at which everything happened in a short period of time, it may not have been immediately clear on what legal basis the write-off of the AT1 bonds took place. Was it a resolution measure of the FINMA? Was it the aim of Article 5a of the Amended Liquidity Regulation? Or was there perhaps another legal basis?
Due to the many questions that arose in this regard, the FINMA decided to issue a statement to further explain the basis for the write-off of the AT1 bonds.[40] In it, the FINMA indicated that a clause has been included in the underlying agreement of the AT1 bonds that makes it possible to write them off in full if special state aid is provided. According to the FINMA, this also happened when the Swiss government and the SNB left liquidity support and guarantees to CS on March 19, 2023. This created a contractual ground for the write-off of the AT1 bonds.
At the same time, FINMA indicates that on the basis of Article 5a of the Amended Liquidity Regulation, it is authorised to issue an order to CS to write off its AT1 bonds.[41] Because of that power and the contractual power to write off, FINMA also issued that order to CS. However, Article 5a of the amended Liquidity Regulation does not seem to require any further contractual basis. It seems sufficient that there is a guarantee provided under the Amended Liquidity Regulation that has been approved. In my view, therefore, the order to write off the AT1 bonds could (strictly speaking) have been issued even if there was no contractual basis for the write-off. The new Article 5a of the Amended Liquidity Regulation is therefore a far-reaching article that can infringe on the rights of all AT1 bonds of systemically important banks in Switzerland (including those of UBS), while it says nothing about the write-down of shareholders. Perhaps even more important is the fact that this law was introduced very suddenly, whereas the legislative resolution was written for precisely such scenarios.
To find out more about the contractual basis for the depreciation, one would have to look at the underlying documentation of the AT1 bonds. Although those details are not known to me, I can understand that it is enough to stir up the AT1 creditors to consider a lawsuit.[42] It is not so much that the AT1 bonds have been written off, but the fact that the shareholders have not first been fully written off.
The SRB wanted to prevent investors from getting the signal that even under the European regime there is a possibility that such AT1 bonds will be the first to be written off. That is why Dominique Laboureix, president of the SRB, has clearly indicated in an interview that he will always apply the hierarchy of the European resolution regime for banks.[43] The Bank of England has also distanced itself from FINMA's decision that in this way it seems to circumvent the creditor hierarchy.[44]
LEGAL CERTAINTY
Legal certainty is of great importance in the financial sector. Large investments are only made if one can trust that their money will not just disappear, but that there is a well-thought-out legal system that is predictable and adhered to. Before the failure of a systemically important bank like CS, that was the resolution regime, but there seems to be less confidence in that than expected. Why was it decided to save CS out of resolution? In resolution, no shareholder approval is required and AT1 bonds can also be written off (after writing off the claims of shareholders).
Although the situation around CS now seems to have stabilized, this abrupt change has made the legal system unpredictable.[45] Last-minute legislation has created a scenario in which the central systems of governance and creditor hierarchy are circumvented. Perhaps the Swiss government has managed to prevent a much worse scenario with this, but at what cost?
[1] Directive 2014/59/EU ('BRRD I'); Directive (EU) 2019/879 ('BRRD II').
[2] Stb. 2015, 431; Stb. 2021 632.
[3] 'ISDA BRRD Implementation Monitor (5th edition) – status of national implementation as of 1 December 2016', isda.org, 2 December 2016 (link).
[4] Art. 16 Regulation (EU) No 806/2014 ('Single Resolution Mechanism Regulation'). The SRB has a leading role in banks directly supervised by the European Central Bank and banks operating in several countries within the EU. The SRB adopts the resolution plan for these institutions and determines whether a bank will go into resolution. The implementation of the resolution is carried out by DNB. In the case of banks that DNB supervises and that are only active in the Netherlands, the powers lie with DNB. In Switzerland, all this is done by FINMA, which can independently decide to proceed with a resolution on the basis of Article 41 (1) of the Bankeninsolvenzverordnung-FINMA.
[5] For banks in the EU under para. 78 and Articles 15(1)(g), 18(5) and 22(2) of the Single Resolution Mechanism Regulation. Under the Swiss regime pursuant to Art. 40 para. 1 sub (a) Bankeninsolvenzverordnung-FINMA.
[6] See also the SRB's 'Introduction to resolution planning' (link).
[7] Par. 21 and Articles 5 and 7 BRRD I; Art. 64 (1) Banking Ordinance.
[8] Par. 28, 33 and 44 and Articles 7(2), 8 and 9 of the Single Resolution Mechanism Regulation.
[9] Art. 64 (2) Banking Ordinance.
[10] 'FINMA considers recovery and resolution planning by the "too big to fail" institutions to be well on track –
but there are still gaps', finma.ch, 24 March 2022 (link).
[11] Some examples: 'Exclusive: Credit Suisse sounds out investors about capital hike', reuters.com, 23 September 2022, (link); 'Credit Suisse Shares Tank As Capital Concerns Spark Reminders Of Lehman Brothers Failure: Here's What We Know', forbes.com, 3 October 2022 (link); 'Credit Suisse Saw $88 Billion Outflows as Confidence Slumped', bloomberg.com, 23 November 2022 (link).
[12] 'FINMA and the SNB issue statement on market uncertainty', finma.ch, 15 March 2023 (link).
[13] 'Credit Suisse Group takes decisive action to pre-emptively strengthen liquidity and announces public tender offers for debt securities', credit-suisse.com, 16 March 2023 (link).
[14] Art. 64 of the Bankenverordnung.
[15] 'FINMA approves merger of UBS and Credit Suisse', finma.ch, 19 March 2023 (link).
[16] Art. 41 para. 2 Bankeninsolvenzverordnung-FINMA. See also the website of FINMA where resolution decisions are announced: (link).
[17] 'How the Swiss 'trinity' forced UBS to save Credit Suisse', ft.com, 20 March 2023 (link).
[18] Verordnung über zusätzliche Liquiditätshilfe-Darlehen und die Gewährung von Ausfallgarantien des Bundes für Liquiditätshilfe-Darlehen der Schweizerischen Nationalbank an systemrelevante Banken (Ordinance on Additional Liquidity Assistance Loans and the Granting of Federal Default Guarantees for Liquidity Assistance Loans from the Swiss National Bank to Systemically Important Banks), 16 March 2023, AS 2023 135 (link original ) (link translation).
[19] Verordnung über zusätzliche Liquiditätshilfe-Darlehen und die Gewährung von Ausfallgarantien des Bundes für Liquiditätshilfe-Darlehen der Schweizerischen Nationalbank an systemrelevante Banken (Ordinance on Additional Liquidity Assistance Loans and the Granting of Federal Default Guarantees for Liquidity Assistance Loans from the Swiss National Bank to Systemically Important Banks), 19 March 2023, AS 2023 136 (original link ) ( link translation).
[20] 'Safeguarding financial market stability: Federal Council welcomes and supports UBS takeover of Credit Suisse', admin.ch, 19 March 2023 (link).
[21] Art. 184 jo. 185 Bundesverfassung der Schweizerischen Eidgenossenschaft.
[22] Under Swiss law, there may be an Absorptionsfusion or Kombinationsfusion. Whereas in a Kombinationsfusion all entities participating in the merger are dissolved and their business operations are transferred to a new company, in an Absorptionsfusion the business operations are transferred to an already existing entity that continues to exist as a surviving entity. In the case of the merger of CS and UBS, therefore, there seems to be an Absorptionsfusion. See also Art. 3 Fusionsgesetz; Begg Peter F.C. (ed.), International Handbook - Corporate Acquisitions and Mergers: Switzerland, Wolters Kluwer 2022, par. Sec. 72.
[23] 'Credit Suisse and UBS to Merge', credit-suisse.com, 19 March 2023 (link).
[24] Art. 3 (2) and 22 Fusionsgesetz; Begg Peter F.C. (ed.), International Handbook - Corporate Acquisitions and Mergers: Switzerland, Wolters Kluwer 2022, par. 73 et seq. ; 'Acquisition of Credit Suisse by UBS', lexology.com, 19 March 2023 (link).
[25] 'Safeguarding financial market stability: Federal Council welcomes and supports UBS takeover of Credit Suisse', admin.ch, 19 March 2023 (link).
[26] "UBS acquiring Credit Suisse – Transcript," ubs.com, March 19, 2023 (link), p. 2.
[27] Art. 12 para. 2 and 18 Fusionsgesetz.
[28] Art. 10a (a) Amended Liquidity Support Regulation.
[29] Art. 10a (b) Amended Liquidity Support Regulation; Articles 14, 15 and 16 of the Fusions Law.
[30] 'Safeguarding financial market stability: Federal Council welcomes and supports UBS takeover of Credit Suisse', admin.ch, 19 March 2023 (link); 'UBS acquisition of Credit Suisse – transcript', ubs.com, 19 March 2023 (link).
[31] 'How the Swiss 'trinity' forced UBS to save Credit Suisse', ft.com, 20 March 2023 (link).
[32] 'Credit Suisse Collapse Burns Saudi Investors', wsj.com, March 21, 2023 (link).
[33] Article 5a of the Amended Liquidity Support Regulation; 'FINMA approves merger of UBS and Credit Suisse', finma.ch, 19 March 2023 (link); 'FINMA provides information about the basis for writing down AT1 capital instruments', finma.ch, 23 March 2023 (link).
[34] Art. 2:23b paragraph 1 of the Dutch Civil Code; n.b. Pannevis, Subordinated claims (Company and law no. 114), Deventer: Wolters Kluwer 2019, para. 61 - 62.
[35] Art. 17(1) Single Resolution Mechanism Regulation.
[36] Art. 15(1)(g) Single Resolution Mechanism Regulation; L. Janssen, 'The EU bank resolution rules and national insolvency law', in: M. Haentjens et al. (eds.), Research handbook on cross-border bank resolution, Cheltenham: Edward Elgar Publishing 2019, p. 112.
[37] Article 34(1)(a) BRRD I and Article 15(1)(a) Single Resolution Mechanism Regulation.
[38] Art. 47 para. 1 sub (a) Bankeninsolvenzverordnung-FINMA.
[39] For example, in a research report on private equity investments in the Netherlands, it was recommended that the law should provide that shareholder loans are regarded as equity capital in the event of bankruptcy, as a result of which they would be subordinated to claims from other creditors, see Kamerstukken II 2017/18, 34 267, no. 11. This advice will also be included in the programme for the reassessment of bankruptcy law, see Kamerstukken II 2017/18, 33 695, no. 17. Critical questions have also been asked about this in the House of Representatives, see, for example, Aanhangsel Handelingen II 2018/19, no. 2273; Aanhangsel Handelingen II 2016/17, no. 565 and 815.
[40] 'FINMA provides information about the basis for writing down AT1 capital instruments', finma.ch, 23 March 2023 (link).
[41] 'FINMA provides information about the basis for writing down AT1 capital instruments', finma.ch, 23 March 2023 (link).
[42] 'Credit Suisse AT1 bondholders consider possible legal action -law firm', reuters.com, 20 March 2023 (link).
[43] 'EU regulators distance themselves from Credit Suisse bond writedowns', srb.europa.eu, 30 March 2023 (link)
[44] 'Bank of England Statement: UK creditor hierarchy', bankofengland.co.uk, 20 March 2023 (link).
[45] See 'How the Swiss 'trinity' forced UBS to save Credit Suisse', ft.com, 20 March 2023 (link), which compares Swiss jurisdiction to a (more) dictatorial state.