On the evening of Sunday, March 19 2023, members of the Swiss government, the Federal Council, accompanied by high representatives of the Swiss National Bank (SNB) and the Swiss Financial Market Supervisory Authority FINMA (FINMA), together with the chairmen of the boards of directors of UBS Group AG (UBS) and Credit Suisse Group AG (Credit Suisse), announced that Credit Suisse would be taken over by UBS. This announcement came after previous attempts by SNB and FINMA to calm and convince the markets of Credit Suisse’s stability over the previous days had failed, and the authorities became convinced that Credit Suisse could not survive independently.
Takeover of Credit Suisse by UBS
The takeover will be accomplished by way of a statutory merger between Credit Suisse and UBS. UBS, the listed parent company of the UBS Group, will be the surviving entity and Credit Suisse, the listed parent company of the Credit Suisse Group, will cease to exist. Shareholders of Credit Suisse shall receive one share in UBS for 22.48 shares of Credit Suisse.
To make this merger possible within the short time available before the opening of the Asian stock exchanges on March 20 2023, the Federal Council resorted to enacting an ordinance on additional liquidity assistance loans. It also granted default guarantees by the Swiss Confederation for liquidity assistance loans by the SNB to systemically important banks (the CS-UBS Ordinance). This ordinance was enacted under emergency law (Article 184 para. 3 and Article 185 para. 3 of the Swiss Constitution) and in it, the Federal Council took several far-reaching decisions in derogation from existing Swiss law:
Suppression of shareholders rights
In principle, the merger between UBS and Credit Suisse is governed by the Swiss Merger Act. The Swiss Merger Act grants the shareholders of the involved entities the right to approve or reject an intended merger in a general meeting of shareholders. However, in this case, the CS-UBS Ordinance states that no such approval is required if the merger is deemed necessary to protect the Swiss national economy and financial system and is carried out in coordination with FINMA. In addition, and under the same conditions, the Federal Council also excluded the application of Articles 11 (preparation of interim balance sheet), 14 (publication of a merger report), 15 (audit of the merger report) and 16 (shareholders’ consultation rights) of the Swiss Merger Act.
Finally, based on the CS-UBS Ordinance, other transaction requirements set out in the Swiss Merger Act may be waived with the consent of FINMA if special circumstances so require. In such cases, FINMA will first consult the relevant cantonal commercial register authorities and the Federal Office of the Commercial Register. In this respect, the Federal Council’s explanatory report merely states that special circumstances exist, in particular, in the event of an emergency and the need for a rapid takeover to protect the Swiss economy and the Swiss financial system.
It is notable that Articles 7 and 105 of the Swiss Merger Act were not expressly excluded. To preserve the rights of the members of a transferring entity, Article 7 provides for the principle of continuity of membership and, thus, that the exchange ratio shall be established in relation to the respective net worth of the merging entities. Pursuant to Article 105 of the Swiss Merger Act, shareholders may petition the court to determine an ‘adequate’ compensation payment within two months of the publication of the merger resolution in the Swiss Official Gazette of Commerce. This is if their shareholder rights are not adequately safeguarded or if the compensation is inadequate. The judgment in such an action applies not only to the requesting shareholder, but to all shareholders in a similar position, regardless of whether they have participated in the litigation.
The exchange ratio of 22.48 shares of Credit Suisse for one share of UBS was set substantially in favour of UBS. Based on the last market prices of both companies, the ratio should have been closer to nine shares of Credit Suisse for one share of UBS. Furthermore, this ratio does not consider the complete write-off of Credit Suisse’s AT1 capital (see below). On this basis, it should not be surprising if shareholders of Credit Suisse were to consider the exchange ratio as inadequate and may attempt to challenge it under the Swiss Merger Act. Were FINMA to waive the applicability of Articles 7 and 105 based on the powers granted to it under the CS-UBS Ordinance, this would merely shift the legal questions to whether such waiver is indeed necessary. This owes to the extraordinary circumstances in this case, a question which has no straightforward answer.
Creation of UBS shares
In order to execute the merger, Credit Suisse shareholders must be able to receive UBS shares. As a general rule, such shares will be created by means of a capital increase regulated, among other things, by Article 9 of the Swiss Merger Act. However, UBS has requested and obtained from the Swiss Takeover Board the right to use part of the UBS shares acquired under its buyback programme for the merger.
Write-off of Additional Equity Capital (AT1)
Concurrently, Article 5a of CS-UBS Ordinance allows FINMA to order the write-off of additional equity capital (AT1) when a systemically important bank receives a liquidity assistance loan under the ordinance. FINMA has used this authorisation and ordered the full write-off of CHF 16 billion of Credit Suisse’s Additional Tier 1 capital (mainly contingent convertible or CoCo bonds).
According to the wording of the Credit Suisse AT1 instruments’ prospectus, the conversion or write-off mechanisms for these instruments is triggered by the occurrence of a viability event. A viability event is deemed to have occurred when:
(i) The Regulator has notified Credit Suisse that it has determined that a write-down of the notes, together with the conversion or write-down/off of holders’ claims in respect of any and all other going concern capital instruments, Tier 1 Instruments and Tier 2 Instruments that, pursuant to their terms or by operation of law, are capable of being converted into equity or written down/off at that time, is, because customary measures to improve Credit Suisse’s capital adequacy are at the time inadequate or unfeasible, an essential requirement to prevent Credit Suisse from becoming insolvent, bankrupt or unable to pay a material part of its debts as they fall due, or from ceasing to carry on its business; or
(ii) Customary measures to improve Credit Suisse’s capital adequacy being at the time inadequate or unfeasible, Credit Suisse has received an irrevocable commitment of extraordinary support from the public sector (beyond customary transactions and arrangements in the ordinary course) that has, or imminently will have, the effect of improving Credit Suisse’s capital adequacy and without which, in the determination of the Regulator, Credit Suisse would have become insolvent, bankrupt, unable to pay a material part of its debts as they fall due or unable to carry on its business.
However, pursuant to the Swiss Capital Adequacy Ordinance (CAO), the capital of a bank considered in view of capital adequacy requirements is composed of Tier 1 capital and Tier 2 capital. The core capital consists of the Common Equity Tier 1 (CET1) and the Additional Tier 1 (AT1). The CAO expressly states that in the event of hardship, losses are absorbed by the capital elements in the following order:
(i) Losses are absorbed by Common Equity Tier 1 before encumbering Additional Tier 1; and
(ii) Losses are absorbed by Additional Tier 1 before being charged to Tier 2 capital.
In its explanatory report, the Federal Council states the following: "The approval of the commitment credit for the granting of a liquidity assistance loan with default risk guarantee is intended to prevent consequences for systemically important banks’ capital endowment that could threaten their existence and thus to make a significant contribution to the continued operation of the borrower and the financial group. Therefore, the granting of a liquidity assistance loan with a default risk guarantee and the commitment credit required for this purpose constitute a decisive state support measure to avoid insolvency and thus the provision of state aid to the bank concerned.
“In this context, FINMA can order the amortisation of additional core capital as soon as the commitment credit is approved. The order in question may be addressed to the borrower and the financial group. It is up to FINMA to define the recipients of this order. The amortisation of additional core capital under Article 5a may also be ordered in view of a takeover or repurchase scenario without which the borrower would have been immediately insolvent."
However, the explanatory report contains no explanation on why FINMA should be allowed to deviate from the rules established in the Capital Adequacy Ordinance, regarding the order in which various capital elements shall be affected by a write-off. In its press release, FINMA did also not provide any further explanation.
In any case, at the last annual general meeting, the shareholders of Credit Suisse voted to remove the conditional share capital and the conversion capital from the company’s articles of association. The proposal of the board of directors was to replace these two instruments with a capital band, a new instrument created by the revision of Swiss corporation law that came into effect on January 1 2023. However, the proposal to introduce a capital band did not achieve the necessary quorum. As a result, Credit Suisse no longer has any capital instrument for the conversion of bonds. This may seem anecdotal, but it is not. Even if conversion was not provided for in the terms of the bonds, it was possible under the applicable law. Thus, the holders of AT1 capital instruments could have requested as a subsidiary option the conversion of the AT1 capital instruments into Credit Suisse shares and thus participated in the merger. This option no longer appears to be available.
It should also be noted that Switzerland has signed over 120 Bilateral Investment Promotion and Protection Agreements (BITs). The purpose of BITs is to afford international law protection from non-commercial risks associated with investments made by Swiss nationals and Swiss-based companies in partner countries. And, vice versa, investments made by the nationals and companies of such partner countries in Switzerland. Such risks include state discrimination against foreign investors in favour of local ones, unlawful expropriation or unjustified restrictions on payments and capital flows. In addition, BITs stipulate obligations on the part of the contracting countries to treat investments made by investors in the other signatory country fairly and equitably. Contracting countries are required to respect state commitments made to specific investors in relation to corresponding investments.
As such, the choice to write-off selectively AT1 capital instruments and failure even to address this question may be used by holders of such written-off instruments as arguments to challenge the legality of this measure in potential claims for compensation against the involved parties.
Validity of the CS-UBS Ordinance and additional measures by the Federal Council
Since it is based on emergency law, the CS-UBS Ordinance is immediately applicable. Moreover, such an emergency ordinance can only be challenged in a particular case and not on an abstract basis. The Federal Council founded the CS-UBS Ordinance on two Articles of the Swiss Constitution: Article 184 (foreign relations) and Article 185 (external and internal security). However, measures taken by the Federal Council in application of these Articles must be limited in time. The validity CS-UBS Ordinance is thus limited to six months and the Swiss parliament will, therefore, have to validate (or not) the measures within the above-mentioned period.
It is not entirely clear, however, what the consequences would be if parliament were to refrain from validating the CS-UBS Ordinance. Generally speaking, to the extent that the transaction has already been consumed and has become a ‘fait accompli’, it should be expected that a non-validation of the ordinance has no direct legal consequences.
The Federal Council also adopted this line of argument, in particular, with respect to the commitment loans granted to Credit Suisse in the amount of 109 billion Swiss francs. Pursuant to Swiss law, such expenses had to be pre-approved by the specialised committees of each chamber of the Swiss parliament. This pre-approval was obtained. However, Swiss law also requires these expenses to be approved by parliament itself afterwards. As a result, parliament convened for a special session in April 2023 in which it failed to approve these expenses.
This is widely perceived to be an expression of political displeasure, based on the understanding that it does not have any (legal) ramifications on the loans themselves, and the Federal Council was quick to emphasise this in a press release. However, there are legal scholars who challenge this position based on the wording of the relevant Swiss law. While this seems to be a minority opinion, it may provide additional arguments to any party challenging specific measures under the CS-UBS Ordinance, because it was or will be negatively affected by the takeover of Credit Suisse by UBS or of the accompanying measures.
The last act of this drama has not yet been written and a plethora of thorny legal questions lie ahead, both for Swiss politics as well as for aggrieved Credit Suisse bond and shareholders.
