Credit Suisse AT1 Notes: The Federal Administrative Court has Ruled

FINMA Order of 19 March 2023

On 19 March 2023, the Swiss Financial Market Supervisory Authority (“FINMA”) instructed Credit Suisse Group AG (“CSG”) to write down all outstanding AT1 instruments with a total nominal value of CHF 16.5 billion.

FINMA justified its order at the time and in the administrative court proceeding essentially as follows:

• Firstly, the conditions set out in the note terms and conditions for a so-called "viability event", which would authorise the bank to write down the notes, had been met. As CSG had not carried out the write-down independently, FINMA had to order the bank to do so.

• Secondly, the instruction to CSG to write down the AT1 capital was a protective measure and the regulator was entitled to take such measures in the event of a risk of insolvency of the bank on the basis of Art. 26 of the Banking Act.

• Thirdly, the order was based on the emergency ordinance of the Federal Council of 16 March 2023, supplemented on 19 March 2023, according to which FINMA could require CSG to write down additional core capital.

FINMA's order was only issued after CSG refused to write down the AT1 instruments: in an e-mail to FINMA dated 19 March 2023, the bank stated that there was no viability event within the meaning of the note terms and conditions that would justify writing off the instruments, because the aid measures provided by the federal government and the Swiss National Bank in the form of loans and guarantees would serve to restore market confidence in Credit Suisse, enable a merger with UBS and create liquidity. These measures were not intended to improve CSG's capital adequacy. However, this is a prerequisite for a viability event that would allow the AT1 instruments to be written down. After the bank informed FINMA that it would not write down the instruments without an explicit order, FINMA issued the order, which was implemented by CSG on 20 March 2023.

Challenge to FINMA's Order by AT1 Creditors

FINMA's order was challenged in the Federal Administrative Court by, among others, three investors who held CSG AT1 capital instruments with a nominal value of USD 6.4 million. The main request of these investors was to overturn FINMA's ruling and instruct CSG (directly or via FINMA) to reverse the write-down of the corresponding AT1 capital instrument ordered by FINMA in order to "put the investors in the position they would have been in if the write-down in question had not been made."

In the proceedings before the Federal Administrative Court, UBS Group AG ("UBS") appeared as a respondent alongside FINMA. UBS is the legal successor to Credit Suisse after the latter was merged into UBS.

Partial Decision of the Federal Administrative Court

The Federal Administrative Court only dealt with the question of the validity of FINMA's order. In particular, it did not address the question of whether UBS should be instructed directly or indirectly via FINMA to reverse the write-off. In this respect, the court only issued a partial decision.

In its partial decision, the court ruled in favor of the investors who had challenged the FINMA order across the board: In summary, the court stated in its 77-page ruling that there had been no "viability event", that there was no basis in banking law for ordering the write-down of the AT1 instruments, and that the Federal Council's emergency ordinance authorizing FINMA to require CSG to write down additional core capital was unconstitutional. The Federal Administrative Court therefore ruled that FINMA's order requiring CSG to write down the AT1 instruments was unlawful.

Significance of the Administrative Court Proceedings for the Civil Law Claims of AT1 Creditors

The Federal Administrative Court's decision received widespread media coverage. The international press, including the Financial Times and the Wall Street Journal, reported on it, as did national and local media. The NZZ wrote of a "hammer blow" ruling, while the Finews portal described it as a "bombshell".

At the same time, the reporting revealed a certain degree of uncertainty as to what this ruling would mean for AT1 creditors which aspect shall be examined in more detail below.

Firstly, it should be noted that the partial ruling of the Federal Administrative Court is not yet legally binding, as it has been appealed by FINMA and UBS to the Federal Supreme Court. Even though the Federal Administrative Court has provided careful and comprehensible reasoning for its decision, it remains completely open how the Federal Supreme Court will rule.

If the partial decision is upheld by the Federal Supreme Court, the Federal Administrative Court will have to deal with the legal claims that have not yet been addressed – unless an out-of-court settlement is reached between the creditors and UBS, possibly with the involvement of the federal government – i.e. the question of whether UBS should be instructed, either directly or via FINMA, to "immediately cancel or reverse" the complete write-off of the AT1 capital instruments. Whether the Federal Administrative Court can issue such an order, which interferes with the legal arrangements of private legal entities, is not to be answered here. However, it is fairly certain that the Federal Administrative Court's decision in this regard will again be brought before the Federal Supreme Court, which could lead to a delay in the resolution of the dispute. It is therefore regrettable that the Federal Administrative Court did not address this issue in its present decision.

However, the decision on these legal claims, which have not yet been dealt with, will likely not be of central importance. Even if a court order to reverse the write-off were not issued, the FINMA order of 19 March 2023 would remain invalid, which would in principle clear the way for civil law claims to be asserted.

In future civil proceedings, the court with jurisdiction under the AT1 note terms (presumably the Zurich Commercial Court) will not be bound by the findings of the Federal Supreme Court's public law division regarding the "viability event". It could therefore deviate from the administrative court's finding that no such event had occurred and dismiss the AT1 creditors' claims against UBS accordingly. However, this seems to be more of a theoretical scenario, as the claim would ultimately be decided by the civil law division of the Federal Supreme Court, which is unlikely to contradict its public law division. Anything else would be a huge loss of face for the Swiss judicial system.

It therefore seems plausible that the AT1 creditors will have to be compensated by UBS if the decision of the Federal Administrative Court is upheld by the public law division of the Federal Supreme Court, even if these proceedings do not concern the civil law claims of the AT1 creditors.

Conversely, if the Federal Supreme Court upholds the appeals by UBS and FINMA, this would severely compromise the AT1 creditors' hopes of compensation: in this case, the FINMA order would remain in force and the civil courts would likely have to take it into account, if the order were to be classified as a constitutive legal act that is fundamentally binding on civil courts. If this were not the case, UBS might argue that the order constitutes an official prohibition on satisfying the AT1 creditors and that performance is therefore objectively impossible. If impossibility were denied and UBS failed to perform, it would be liable for damages to the AT1 creditors if it were at fault. However, fault would probably be denied due to FINMA's order to write off the AT1 instruments.

Admittedly, we are moving into the realm of speculation here. However, from a practical point of view alone, it is difficult to imagine that UBS will be obliged to satisfy the AT1 creditors if a FINMA order prohibiting this remains in force.

Outlook

The decision of the Federal Supreme Court's public law division might indirectly have such a central impact on the civil law status of UBS and AT1 creditors that, if FINMA’s and UBS' appeals are dismissed, the search for an out-of-court settlement is likely to become the focus of consideration for all parties involved. The extent to which the federal government will be involved here depends on any legal claims UBS may have against the federal government which cannot be assessed here.