Investor Protection and Transparency Principle in Light of Credit Suisse AT1 Bonds
Introduction
Swiss Financial Markets Supervisory Authority (“FINMA”), through its decision dated 19 March 2023, approved the merger of Credit Suisse with UBS Group AG (“UBS”) and to write down the Additional Tier 1 capital bonds (referred to as AT1) issued by Credit Suisse, with a total value of approximately CHF 17 billion (“FINMA Decision”).[1] With the write down of Credit Suisse’s AT1 bonds, the receivable rights of bondholders lost their economic value. On the other hand, within the scope of the merger transaction, Credit Suisse shareholders were allocated approximately three billion Swiss francs. FINMA Decision and the situation of the shareholders led a large number of bondholders to bring lawsuits against such decision before the Swiss Federal Administrative Court (“Administrative Court”), and even liability proceedings before the New York courts).
In the legal proceedings initiated, bondholders appealed the FINMA Decision, on the grounds detailed below, and the discussions that started within this framework flourished debates on the position of the investor under capital markets law. Finally, the fact that the full text of the FINMA Decision was made available to all investors only in May 2023 opened a new window to the discussions in terms of the principle of transparency. In this Newsletter article, the claims of the plaintiffs in the annulment proceedings against the FINMA Decision and the principle of investor protection will be summarized under Turkish law. In addition, the hierarchy between shareholders and creditors in absorbing the risk of loss, being the hot topic after the FINMA Decision, will be discussed within the framework of the regulations in the European Union and Türkiye, and finally, the developments in May 2023 will be conveyed in the context of the principle of transparency.
Claims of Bondholder Investors Against FINMA Decision
FINMA explained the legal grounds for the write down of the AT1 bonds with its press release on 23 March 2023, following announcing that it had authorized the merger transaction and decided to write down the AT1 bonds on 19 March 2023.[2] In the statement, FINMA underlined the contractual clause under AT1 bond issuance terms as the legal basis for the write down, stating that the triggering event has occurred and the governmental aid was provided, which was both defined in the issuance documents.
However, within the legal period following the FINMA Decision, many AT1 bondholders filed annulment lawsuits before the Administrative Court. As covered by international press, the arguments go that the FINMA Decision lacks legal basis, discriminates between shareholders and bondholders, restricts the right to property, was not convenient for the purpose of curing Credit Suisse’s financial structure and was not proportionate.
Certain arguments against the FINMA Decision will be discussed directly on the facts of the case, such as, that government aid was not actually provided even though the triggering event took place, and therefore the conditions in the bond documents were not fulfilled. However, whether the limitation to the property rights of bondholders is necessary, reasonable and finally proportionate from the constitutional law gaze requires an assessment from a broader perspective within the scope of public law. Within the context of these discussions, the future decision of the Administrative Court will reveal the position of the judiciary at the first instance.
Principle of Investor Protection in General
The fact that these steps taken directly related to the Additional Tier 1 capital bonds, which was created for banks, regarding the financial structure of Credit Suisse, which is a bank, reveals the intense relationship of this issue with banking law. However, the facts that the bonds in question were also capital market instruments and that a measure was applied on the property rights of capital market investors, draw the issue into the scope of capital markets law. In this context, the situation of investors, who are capital market subjects, needs to be evaluated, especially within the framework of the principle of investor protection.
As set forth in the Article titled Purpose of the Capital Markets Law No. 6362 (“CML”), the protection of the rights and interests of investors is among the fundamental principles of legal regulations in capital markets. In this respect, investor protection is not an independent and isolated aim; it is intertwined and mutually reinforcing with the realization of the objective of “ensuring the functioning and development of the capital market in a reliable, transparent, efficient, stable and fair environment”.
The individual investor in capital markets assumes the role of a participant through the demand it creates for the issued securities, and is also seen as a market actor through its transactions with parties other than the issuer in secondary markets.[3] Finally, individual investors receiving services from intermediary institutions providing services in capital markets may also act as consumers before these intermediary institutions.[4] While introducing legislative pieces within the framework of the principle of investor protection, resolving information asymmetry is prioritized so that the investor is affected as little as possible, and that a safe investment environment is ensured for investor’s legal transactions with the issuer or with other market actors.
In terms of the FINMA Decision and the subsequent annulment proceedings, it should be stated that both the shareholders holding Credit Suisse’s publicly traded shares and the bondholders are both investors in terms of capital markets law. Shareholders and bondholders, both may act as participants by purchasing the issued capital market instrument from the issuer, or they may assume the role of market actors by trading these instruments in the secondary markets. The discrimination claim in the annulment proceedings before the Administrative Court is peculiar due to this shared title; the principle of investor protection, being one of the fundamental principles, may be applied to both shareholders and bondholders.
Hierarchy of Shareholders and Creditors in Absorbing the Financial Risk
It is critical whether there is a hierarchy between shareholders and bondholders, who are both investors in terms of capital market law, in terms of the absorbing the risk of loss. Indeed, one of the main lines of the FINMA Decision debates was that Credit Suisse shareholders were entitled to a provision of approximately three billion Swiss francs while the AT1 bonds were completely written down; in other words, Credit Suisse’s financial risk was firstly absorbed by the AT1 bondholders, bypassing the shareholders. For the purposes of this Newsletter article, such alleged hierarchy may be traced in the EU and Turkish regulations in order to discuss the issue in terms of principles from the perspective of Turkish law.
The EU Directive 2014/59/EU[5] (“Directive”) outlines the basis for EU member states, which implemented it into their domestic laws, and sets out the framework for the rescue of financial institutions and the resolution of their financial crises. Articles 48 and 60 of the Directive govern the order for write downs, and lists the sequence as follows: firstly, Common Equity Tier 1; secondly, Additional Tier 1; and finally, Tier 2. Due to the legal nature of the Directive, reservations for not contradicting with the insolvency and liquidation regulations of the Member States were put. Nevertheless, the spirit of the Directive provides that the risk should first be absorbed by the shareholders, then by recourse to the elements constituting the “Additional Tier 1 capital” embodied in AT1 bonds, and after these two steps, if still necessary, to the elements constituting the Tier 2 capital.
In Türkiye, the Banking Regulation and Supervision Agency (“BRSA”) is authorized to regulate matters relating to the equity of banks. Secondary regulations under the Banking Law No. 5411 regarding this issue are mainly the Regulation on Equity of Banks (“Regulation on Equity”) and the Communiqué on Principles Regarding Debt Instruments to be Included in Equity Calculation by Banks (“Communiqué”). Article 7 of the Regulation on Equity regulates the mandatory terms regarding the bonds that will constitute Additional Tier 1 capital. Accordingly, in the event that the operating license of the relevant bank may be revoked or transferred to the Savings Deposit Insurance Fund due to the losses incurred by the relevant bank, the bonds in question should be written down against the losses or converted into shares. Article 5 of the Communiqué further regulates that Additional Tier 1 capital (AT1) bonds are to be considered before Tier 2 capital bonds regarding the sequence of write down, value reduction or conversion into equity shares. Although the Communiqué does not contain as clear and detailed provisions as the Directive on the sequence of write down, the provisions of the Regulation on Equity define paid-in capital as “the capital that comes after all other receivables in terms of the right to claim in the event of liquidation of the bank”. In this respect, the BRSA regulation can be considered to be in parallel with the EU regulation.
It is clear that the Directive is not applicable in Switzerland, which is not an EU Member State and therefore is not subject to EU law. Among the arguments for the legal grounds of the FINMA Decision, the contractual basis of the measure is emphasized without mentioning such hierarchy. Such argument in favor of the FINMA Decision, underlines that Credit Suisse is not going through liquidation, and that the write down was, in this respect, an execution of the contractual provision in the AT1 bond terms rather than an insolvency proceeding.
Principle of Transparency
Finally, after the FINMA Decision, the fact that the decision and related documents, which were the basis of FINMA’s press release dated 19.03.2023, were not accessible to bondholders for a certain period of time, drew attention in terms of the principle of transparency. The fact that the FINMA Decision was only made publicly available at the beginning of May, more than a month after the press release, served as a ground for claims by bondholder investors that the principle of transparency had been violated.
Under Turkish law and capital markets principles, as known, ensuring a transparent functioning is among the objectives of the CML. The application of this principle is essentially embodied in the effort to eliminate information asymmetry between individual investors and issuers and other market actors. The principle of transparency constitutes the main motivation behind both in the disclosure requirements at the issuance of capital market instruments, and in the public disclosure legislation for circumstances that may affect investor decisions in publicly traded companies. The criticisms against the FINMA Decision serve as a reminder: it is important that not only the capital markets authority, but also other regulatory and supervisory authorities, should take measures to ensure transparency, particularly for the benefit of the addressee of the action in their administrative actions affecting capital market investors.
Conclusion
FINMA Decision approving the merger of Credit Suisse and UBS and to write down Credit Suisse’s AT1 bonds, led to a large number of annulment proceedings by AT1 bondholders before the Swiss Federal Administrative Court; and a wide international debate on the issue. FINMA cited the provision under AT1 bonds’ terms as the legal basis for the transaction, while bondholders claimed in their appeal that their property rights were violated and that the measure was discriminatory and contrary to the hierarchy between shareholders and bondholders.
The principle of investor protection, which is one of the fundamental principles of capital market law, is an umbrella principle as it covers both parties to the discrimination claim, namely shareholders and bondholders. However, until the FINMA Decision was made available to the public (in particular to the bondholders), discussions and concerns continued in relation to the principle of transparency.
Regardless of the fate of the FINMA Decision before the Swiss courts, at the heart of the debate is whether the hierarchy between shareholders and bondholders, which is claimed to be a general principle, actually exists. When analyzed from a comparative law perspective, the detailed regulations on bank rescue in EU law, firstly resorts to the shareholders and then to the AT1 bondholders in terms of absorbing the risk of loss. Although the BRSA regulation in Turkish law does not contain detailed and clear statements to the extent of the Directive, it is shaped in parallel with the EU regulation, as it was modelled after Basel III standards.
- “FINMA approves merger of UBS and Credit Suisse” https://www.finma.ch/en/news/2023/03/20230319-mm-cs-ubs/. (Access Date: 02.07.2023)
- “FINMA provides information about the basis for writing down AT1 capital instruments” https://www.finma.ch/en/news/2023/03/20230323-mm-at1-kapitalinstrumente/. (Access Date: 02.07.2023)
- Çetin, Nusret: “Sermaye Piyasası Hukukunda Yatırımcının Korunması İlkesinin Teorik Analizi”, Gazi Üniversitesi Hukuk Fakültesi Dergisi, V. XV, Y. 2011, Issue. 1, p. 5 ff.
- Töremiş, Hatice Ebru. Sermaye Piyasası Faaliyetleri Bağlamında Yatırımcının Tüketicinin Olarak Korunması, 1st Edition, Seçkin Yayıncılık, 2022, p. 48 ff., Çetin, p. 7.
- For the full text of the EU Directive numbered 2014/59/EU and titled Establishing a Framework for the Recovery and Resolution of Credit Institutions and Investment Firms, please see https://eur-lex.europa.eu/legal-content/EN/TXT/PDF/?uri=CELEX:32014L0059. (Access Date: 02.07.2023)
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