On 26 March 2015, Credit Suisse issued USD 4 billion senior unsecured debt that intends to be eligible to meet the Financial Stability Board’s proposal and envisaged future Swiss standards for instruments counting towards a total loss absorbency capacity (TLAC) requirement.

By René Bösch/Benjamin Leisinger (Reference: CapLaw-2015-15)

1) Background and Developments

a) The Idea

In January 2010, in a guest article in The Economist, Paul Calello, the late head of Credit Suisse AG’s investment bank division, and Wilson Ervin, Credit Suisse AG’s former chief risk offi cer, proposed a new process for resolving failing banks. Their article entitled From bail-out to bail-in presented the idea to give authorities the power to order a reduction in creditors’ claims (haircut) or a conversion of such claims into equity of the insolvent debtor (debt/equity-swap, together with a haircut referred to herein as “bail-in”) before public money (taxpayers’ money) must be used to protect the systemically relevant functions, or operating liabilities generally, of a bank.

b) The Financial Stability Board’s Recommendations for G-SIFIs

On 20 October 2010, the Financial Stability Board (FSB) recommended that financial institutions that are clearly systemic in a global context (so-called G-SIFIs) should have loss absorption capacity beyond the minimum agreed Basel III standards. In particular, the FSB recommended that G-SIFIs should have a higher share of their balance sheets funded by capital and/or by other instruments which increase the resilience of the institution as a going concern. Amongst others, the FSB mentioned a quantitative requirement for debt instruments or other liabilities represented by “bail-inable” claims, which are capable of bearing loss within resolution, thus enabling creditor recapitalization and recovery while maintaining vital business functions. At the Seoul Summit in 2010, the G20 leaders endorsed these recommendations.

In October 2011, the FSB published its Key Attributes of Effective Resolution Regimes for Financial Institutions (the Key Attributes) and proposed that resolution authorities should have a broad range of resolution powers available, including the possibility to carry out bail-in within resolution as a means to achieve or help achieve continuity of essential functions either (i) by recapitalizing the entity hitherto providing these functions that is no longer viable, or, alternatively, (ii) by capitalizing a newly established entity or bridge institution to which these functions have been transferred following closure of the non-viable firm (the residual business of which would then be wound up and the firm liquidated).

c) Switzerland’s Bail-in Regime

On 1 September 2011, Switzerland enacted a revised bank resolution regime in the Banking Act, that explicitly provided for the possibility of the Swiss Financial Market Supervisory Authority FINMA (FINMA) to order a bail-in. On 1 November 2012, Switzerland’s Ordinance of the FINMA on the Insolvency of Banks and Securities Dealers (BIO-FINMA) entered into effect. In Section 3 on “Corporate Actions”, articles 47 to 50 BIO-FINMA contain more detailed rules on how FINMA can order a bail-in. By virtue of the amendments of the Banking Act and the enactment of the BIO-FINMA, Switzerland was among the first movers to meet the requirements recommended for financial institutions by the FSB in the Key Attributes.

Once the new amendment to the Banking Act enters into effect (envisaged for late in 2015 or early in 2016), FINMA’s resolution and bail-in authority also applies to bank holding companies of a financial group that are domiciled in Switzerland (see CapLaw-2014-23 for more information).

d) The Financial Stability Board’s Status Report and TLAC Proposal

On 2 September 2013, the FSB reported to the G20 on the status of the progress to end the too-big-to-fail (TBTF) conundrum. While showing some progress, the FSB also stated that many FSB jurisdictions need to take further legislative steps to implement the Key Attributes fully, in substance and scope. The FSB highlighted that important areas where jurisdictions need to act relate to the vesting of resolution authorities with bail-in powers and other resolution tools, powers for cross-border cooperation and the recognition of foreign resolution actions. Additionally, the FSB mentioned that a systemically important financial institution (SIFI) needs to have sufficient resources to absorb losses in resolution – a feature it referred then to as “gone concern loss absorbing capacity” (GLAC). The FSB committed to prepare proposals for consideration by end-2014 on the nature, amount, location within the group structure, and possible disclosure of such GLAC.

On 10 November 2014, the FSB published its proposal for a common international standard on now so-called “total loss absorbency capacity” (TLAC) for G-SIFIs (the Proposal) and asked the industry for consultation and comments until the consultation period ended on 2 February 2015. The Proposal specifi cally featured a draft term sheet (the Term Sheet) with the proposed features of TLAC instruments. According to the Term Sheet, the objective of the proposed minimum TLAC requirement is to ensure that G-SIFIs have the loss absorbing and recapitalization capacity necessary to help ensure that, in and immediately following a resolution, critical functions can be continued without taxpayers’ funds (public funds) or financial stability being put at risk. In order for debt instruments not qualifying as regulatory capital of the G-SIFIs to be eligible to count towards the TLAC requirement, the Term Sheet states that certain elements must be met.

The core features for such external TLAC set forth in Sections 8 through 17 of the Term Sheet are as follows: (1) issued and maintained by resolution entities, (2) being unsecured, (3) having a minimum remaining maturity of at least one year, (4) not qualifying as an “excluded liability” (i.e., not be an insured deposit, not be callable on demand without supervisory approval, generally not be funded directly by the issuer or a related party of the issuer, not qualify as a derivative or have derivative-linked features, not arise otherwise than trough a contract, not be senior to normal unsecured creditors under the relevant insolvency law, not be excluded from bail-in), (5) being able to absorb losses prior to excluded liabilities (to be read as “prior to creditors of operating liabilities of the bank”, in the authors’ understanding based on the stated objective of TLAC and the comments to the FSB Proposal in the consultation) in insolvency or in resolution by way of either contractual, statutory or structural subordination without giving rise to material risk of successful legal challenge or compensation claims, (6) not be subject to set off or netting rights that would undermine their loss-absorbing capacity in resolution, (7) not be redeemable without supervisory approval, except when replacing eligible TLAC with liabilities of the same or better quality and the replacement of liabilities is done at conditions which are sustainable for the income capacity of the bank, (8) either be governed by law of the jurisdiction in which the relevant resolution entity is incorporated, or if subject to the law of another jurisdiction, include legally enforceable contractual provisions recognizing the application of resolution tools by the relevant resolution authority if the resolution entity enters resolution, unless there is equivalent binding statutory provision for cross-border recognition of resolution actions, and (9) contain a contractual trigger or be subject to a statutory mechanism which permits the relevant resolution authority to expose TLAC to loss or convert to equity in resolution.

e) Switzerland Endorsing the Idea of TLAC

In light of the FSB Proposal, the Final Report of the Group of Experts on the Further Development of the Financial Market Strategy dated 1 December 2014 (called after the chairman of that Group of Experts, Professor Aymo Brunetti, the “Brunetti Report”) also recommended to supplement the Swiss TBTF regime with binding TLAC requirements so that sufficient liabilities are available to make recovery or orderly resolution possible. On 18 February 2015, the Swiss Federal Council in its evaluation report on Switzerland’s TBTF provisions endorsed this recommendation and stated that Switzerland intends to change its laws to introduce a TLAC requirement even if the Brisbane Summit of the G20 does not result in an internationally agreed standard for TLAC.

2) Credit Suisse’s Inaugural Issuance

On 23 March 2015, Credit Suisse launched its inaugural issuance of newly designed senior debt instruments that are designed to meet the requirements proposed by the FSB’s Term Sheet. The USD 1.5 billion 2.750% Senior Notes due 2020 and USD 2.5 billion 3.750% Senior Notes due 2025 (together, the Notes) have been issued by Credit Suisse Group Funding (Guernsey) Limited, a special purpose vehicle to implement the new funding strategy, on 26 March 2015 on a Rule 144A/RegS basis and are guaranteed by Credit Suisse Group AG (CSG). The Notes will be listed on the SIX Swiss Exchange Ltd.

For Swiss withholding tax reasons, the Notes are issued by a special purpose vehicle. However, the Notes are guaranteed by CSG, the relevant Swiss resolution entity in FINMA’s preferred single-point-of-entry resolution strategy. Because of this, the Notes are indirectly (and economically) issued by CSG. It is also worth noting in this context that in the Swiss bail-regime, a guarantee does not present a security that would limit the availability of the respective liability for bail-in under the BIO-FINMA. Notwithstanding this, upon the opening of restructuring proceedings with respect to Credit Suisse AG and/or CSG, a prepackaged automatic issuer substitution results in CSG becoming the principal debtor under the Notes and the guarantee falling away as a result of this. By means of these contractual features, the Notes would be debt of the resolution entity and completely unsecured during restructuring proceedings with respect to CSG and, hence, subject to a statutory bail-in by FINMA, once CSG is subject to the bail-in regime.

Because the Notes will be the debt of the holding company CSG at the relevant time, the Notes would absorb losses through a statutory full or partial conversion and/or write-down ordered by FINMA in the course of restructuring proceedings with respect to CSG. As senior unsecured instruments, the Notes could only be fully or partially converted into equity of CSG or written-down under Swiss law after shareholders of CSG and holders of subordinated debt of CSG. However, the structure and mechanics of the Notes, through structural subordination, permit that the instruments be fully or partially converted or written-down by FINMA prior to creditors of operating liabilities of the bank Credit Suisse AG. Moreover, as the Notes are governed by New York law, recognition of the exercise of such a resolution power by FINMA in the competent New York courts is safeguard by appropriate contractual clauses (recognition and acknowledgement clause). The Notes also contain a set-off prohibition and require approval by FINMA prior to redemption, to the extent required at the time. In order to deal with the issue of Swiss withholding tax application after an automatic issuer substitution, the Notes provide for the exchange of the Notes for newly issued notes if, after the completion of the Swiss restructuring proceedings with respect to CSG, the Notes have not been fully written-down and/or converted into equity of CSG and CSG is or would be required to deduct Swiss withholding tax from interest payments on the Notes under Swiss laws in effect at such time.

An internal down-streaming instrument issued by a non-Swiss branch of Credit Suisse AG to Credit Suisse Group Funding (Guernsey) Limited and its features provide for the basis of a recapitalization by FINMA of the bank Credit Suisse AG or other Credit Suisse group companies in the course of restructuring proceedings with respect to CSG without opening restructuring proceedings with respect to Credit Suisse AG or such other group company (single point of entry, top-down) and for the down-streaming instrument absorbing losses prior to any operating liabilities of Credit Suisse AG.

3) Outlook

It remains to be seen what the final proposal and requirements published by the FSB for TLAC-eligible instruments will be. The final FSB TLAC requirements are expected by the end of 2015 and, according to the existing FSB Proposal, are intended to apply by 1 January 2019.

However, in light of the Swiss Federal Council’s clear commitment to implement a TLAC requirement, the obvious need to further address the TBTF conundrum, and Switzerland’s past history as a fast mover in this area, Swiss systemically relevant financial institutions have already shifted their focus on developing instruments that serve the purpose of protecting operating liabilities, and the systemically relevant functions in particular, in a gone concern and to allow a recapitalization of the bank (or banks) of the financial group in line with FINMA’s single-point-of-entry resolution strategy, i.e., without opening restructuring proceedings with respect to the bank itself.

René Bösch (rene.boesch@homburger.ch)
Benjamin Leisinger (benjamin.leisinger@homburger.ch)