AT1 bondholders have little room for recourse if enterprise fails: lawyers

INVESTORS holding on to Additional Tier-1 (AT1) bonds could face difficulty getting their money back if there are clauses in a bond’s contracts that allow the bondholders’ priority to be revoked in the event of a restructuring.

“If the bond instrument says there are some capital requirements or clauses which reverse the order, bondholders would be pushed downwards,” explained a lawyer.

Seeking recourse could be difficult if the clauses were there when investors signed on the dotted line, he added.

This was the case with Credit Suisse’s AT1 perpetual bonds, which stated: “If a write-down event occurs… interest on the notes shall cease to accrue, the full principal amount of each note will automatically and permanently be written down to zero. Holders will lose their entire investment in the notes, and all rights of any holder for payment of any accrued but unpaid interest or any other amounts under or in respect of the notes shall become null and void. Each holder and beneficial owner of a note agrees, by accepting a direct or beneficial interest in such note, to be bound by and consents to the application of the write-down.”

The Swiss government announced on Mar 20 that US$17 billion of Credit Suisse perpetual bonds would be written off as part of UBS’ takeover of the bank.

Some holders of those bonds are reportedly considering legal action. Lawyers who spoke to The Business Times said that they have been receiving calls from clients holding similar bond instruments issued by other institutions.

Shaun Leong, partner, dispute resolution, Withers KhattarWong, said the unique circumstances of UBS’ takeover of Credit Suisse could be enough to warrant a legal challenge.

“It may be that even if there is the power to write down AT1 bonds, that power must be exercised in good faith, which is an important principle under Swiss law,” he said.

He expects investors to challenge the decision in cross border litigation or international arbitration, with claims based on breaches of contract and economic torts such as unlawful conspiracy to interfere with rights.

The writedown of Credit Suisse debt has led to a sell-off among similar-tiered bonds by other issuers.

Asian banks appear to have better convinced investors of their safety. Asia’s AT1 bond prices have fallen 4.3 per cent on average – lower than the double-digit decline in many markets, a Natixis CIB report last week indicated.

The decline in Asia’s Additional Tier-2 (AT2) bonds is also relatively minimal at 1.1 per cent, the Natixis CIB data indicated.

There is no reason to believe the acute risk-off environment will not hit Asian financial institutions or high-yield issuers harder if risk sentiment stays cautious, said Alicia Garcia Herrero, chief economist for Asia-Pacific at Natixis CIB, and her colleague, senior economist Gary Ng.

Withers KhattarWong’s Leong advised investors to assess the best possible actual value of their investments, as well as the enterprise’s fundamentals before investing.

“Given that AT1 bonds would come undone when an enterprise fails, it seems imperative that investors consider the soundness and stability of the enterprise,” he said.

Lawyers also advised investors to read the fine print in these bond instruments carefully before buying.

“When you purchase a bond, you should look carefully at the bond instrument to see what are your rights. When there is a default in payment, what can you do? Be aware of your rights,” said a restructuring lawyer who declined to be named.

Perpetual notes issued by banks in Singapore have a similar loss-absorption mechanism as the AT1 perpetual bonds issued by Credit Suisse. This allows the Monetary Authority of Singapore (MAS) to make the call on a writedown of AT1s, based on documentation for DBS and UOB perpetual bonds.

To allay investors’ concerns following the Swiss government’s decision on Credit Suisse’s AT1s, MAS said it aims to abide by the hierarchy of claims in liquidation. This means shareholders will absorb losses before AT1 and AT2 debtholders.

“Creditors who receive less in a resolution compared with what they would have received had the FI (financial institution) been liquidated would be able to claim the difference from a resolution fund that would be funded by the financial industry,” the central bank added.

This, however, does not seem to have calmed investors’ fear entirely, as most AT1 bonds issued by local banks have continued to earn higher yields than the coupon rate offered.