CoCo Bonds, Clawbacks, and Credit Suisse. What next for private investors and sovereign funds?

Date: 26 Apr 2023

Karen Jones

The various scandals, rumours, and half-truths have made the financial markets jittery, and the fever with which information spreads, particularly bad, results in panic, even if unwarranted. It is without question that the SVB (Silicon Valley Bank) and Signature bank collapses had a critical impact on the trust in banking and whether people believed Credit Suisse could sustain that. Swiss sentiment said “It’s about time that a government has the intent to do the obvious, which at least means clawing back the misallocated “rewards” for bad management.”

On 19 March 2023, the Swiss investment bank UBS Group agreed to buy Credit Suisse for CHF 3 billion in an all-stock deal brokered by the government of Switzerland and the Swiss Financial Market Supervisory Authority. The combination is expected to create a business with more than USD 5 trillion in total invested assets.  With large investors reported from Saudi Arabia and Qatar in Credit Suisse who will have sustained substantial losses, Citywealth Editor, wondered what lessons are learned for private investors and sovereign funds going forward?

The emergency deal was made because Credit Suisse, one of the largest banks in Switzerland, up until this time, reported significant losses related to its exposure to the Archegos Capital Management hedge fund. In March 2021, Archegos defaulted on margin calls from several banks, including Credit Suisse, which had extended substantial loans to the fund. As a result, Credit Suisse has reported a loss of $4.7 billion for the first quarter of 2021, the largest quarterly loss in its history.

In addition to the losses related to Archegos, Credit Suisse has also faced challenges related to the collapse of Greensill Capital, a supply chain finance firm that it had provided financing to. Greensill’s insolvency has led to significant losses for Credit Suisse’s clients and raised questions about the bank’s risk management practices. The losses have led to management changes at Credit Suisse, with the bank’s CEO and other senior executives stepping down. UBS has also seen management changes to handle the new entity.

The losses at Credit Suisse, also highlight the risks involved in providing financing to highly leveraged clients such as hedge funds. The incident has also raised questions about the adequacy of risk management practices at major banks and the need for stronger regulatory oversight when most financial services operations have been through multiple regulation changes already.

Nicholas Connon, CEO, Quintel Intelligence who is a member of The Association of British Investigators and works with UHNW’s globally to secure and recover assets responded saying he thinks more was known than just a surprise; “Investors in Credit Suisse will not have been particularly intimidated by the rumours and scandals that have circulated the bank over the last few years. Professional advisors will have had a far greater insight into the operations of Credit Suisse and been able to draw an opinion on whether they remained, on paper, stable. It is, however, important not to overlook the market’s sentiment toward the various scandals, rumours, and half-truths. The markets are jittery, and the fever with which information spreads, particularly bad, results in panic, even if unwarranted. It is without question that the SVB (Silicon Valley Bank) and Signature bank collapses had a critical impact on the trust in banking and whether people believed CS could sustain that.”

Leonard Vijverberg, a senior associate in Lenz & Staehelin’s Private Client group in Geneva forwarded me thoughts from the firms client information of the situation which agreed with Nick Connon’s point: “Credit Suisse was experiencing a crisis of confidence and faced outflows of clients funds, intensified by the recent events in the US financial markets.”

One of the investors sustaining these losses is reported to be Saudi Arabia’s Crown Prince Mohammed bin Salman who in 2020 directed the country’s sovereign wealth fund, the Public Investment Fund (PIF), to invest $1.5 billion in Credit Suisse. The investment was part of the Crown Prince’s strategy to diversify Saudi Arabia’s economy and reduce its dependence on oil revenues. The PIF is one of the largest sovereign wealth funds in the world, and it has made a number of high-profile investments in recent years, including in tech companies like Uber and electric car maker Lucid Motors.

The investment in Credit Suisse was reportedly made through the Saudi National Bank, which is majority-owned by the PIF. The move was seen as a vote of confidence in Credit Suisse by the Saudi government, and it helped the bank to raise capital at a time when it was facing regulatory and legal challenges.

However, the recent losses at Credit Suisse and rescue have raised questions about risk management practices in banks and the wisdom of the Saudi investment. Also issues circle within Switzerland about the Credit Suisse operation and how this could happen, as well as the ethical policies of Credit Suisse taking money from Saudi. It remains to be seen how the situation will develop.

A Swiss trustee, who preferred to remain anonymous said, “I think that these investors were let down by their advisors who either did not do their homework on the details of the investment or they assumed that their political clout would see them through should problems arise. I am not a Swiss banking expert about the “CoCo Bonds” that they bought, but I understand that the terms of the bonds were clear that they could lose money if there were losses to depositors.”

Citing an article from the European Corporate Governance institute (ECGI blog), written by Zhenyu Wang,  Professor of Finance at Indiana University who was formerly a Head at the Federal Reserve Bank of New York, it says, “The takeover wiped out the value of AT1 CoCo bonds while giving a positive valuation to equity, which appeared to violate the absolute priority between debt and equity. This move caught bond investors off guard, and some were outraged. The event raises significant questions about CoCo bonds.” Link to the article below.

On the topic of future, investor protection, Nick Connon says, “Investors can better protect themselves through proactive, independent due diligence which means seeking information, not just receiving it, and continuous sentiment monitoring, both digital and human.”  

However, as the implications are not just to investors but also the Swiss economy, a further point was made: “The Credit Suisse story is not over yet. The Swiss government is looking for ways and means of clawing back compensation for senior management. It’s about time that a government has the intent to do the obvious, which at least means clawing back the misallocated “rewards” for bad management. They are also looking for ways of carving out the CS Swiss bank branches to spin that off into a new bank so that UBS will not have a total monopoly…again some innovative thinking rather than just letting raw, brutal capitalism prevail.”

Lenz & Staehelin’s missive confirms this, citing CS First Boston in their comments “Initial information indicates that UBS will specifically keep the Swiss bank of Credit Suisse Group so Credit Suisse (Schweiz) AG, but that it designated certain other assets, particularly in the investment banking area, as non-core. To date, it cannot yet be assessed how this will impact Credit Suisse’s already published plans to spin-off its investment banking division into a newly formed entity.”

So, are there lessons to learn? It seems the jury is out on that. As the deal is thrashed out, it is clear fingers have been burned and more questions will be asked. The good news is the Swiss have one of the best governments in the world, whilst this is of little consolation for the taxpayers or the investors right now, it should ensure both don’t learn a painful lesson from the government on top.

A lawyer expert to consult on this topic was recommended as Mark Barmes of Lenz & Staehelin who specialises in cases involving bank regulation.

ECGI: See link

Zhenyu Wang, is the Edward E. Edwards Professor of Finance at the Kelley School of Business, Indiana University who was formerly the Head of the Financial Intermediation Function at the Federal Reserve Bank of New York