Swiss CoCo litigation may have a broader payoff

LONDON, March 23 (Reuters Breakingviews) - Credit Suisse's (CSGN.S) CoCos are shaping up to be the bondholder litigation case of the century. Investors in the bank's 16 billion Swiss francs ($17.5 billion) of contingent convertible bonds think authorities were wrong to wipe them out as part of a state-sponsored rescue by UBS (UBSG.S). Recovering any value will be tricky and take time. Still, there are broader reasons to put up a fight.

Investors are in uproar over the government's decision to wipe out Credit Suisse's Additional Tier 1 securities over the weekend, while preserving 3 billion Swiss francs for shareholders. Swiss regulator FINMA on Thursday said the bond prospectus allowed for such an outcome in case of a so-called viability event, which kicks in if the government props up the bank. So did a new emergency law passed on Sunday.

That "belt and braces" argument may not deter litigants. They can argue that state support for Credit Suisse did not represent a viability event because the authorities injected liquidity but not capital. Meanwhile, the new law looks a lot like expropriation, which investors can challenge in court.

Credit Suisse's AT1 bonds are currently trading at around 6% of par value, rather than the zero the Swiss authorities declared them to be worth. That implies bondholders think they may eventually get some money back.

Still, litigation is a long road. Creditors of Dutch bank SNS successfully sued over the government's expropriation of bonds worth 700 million euros in 2013, but had to wait eight years to get their principal back with interest. A similar outcome here would imply the bonds would be worth around 60% of par value, assuming 8% accrued interest and applying a discount rate of 15%. In other words, investors are attaching a one-in-10 probability to that outcome.

But even if bondholders were to win in court, they might not get a full payout. After all, if Switzerland had applied its resolution framework, the most AT1 bondholders could have hoped to receive was the 3 billion Swiss francs UBS set aside for shareholders. That's less than 20% of the bonds' par value.

Still, there are reasons for the Swiss government to seek a truce. If it gets a reputation for violating bondholder rights its remaining banks, especially UBS, will have to pay a higher price for their debt.

Bondholders have other reasons to fight, too. If Switzerland can change the rules overnight, any other country could too. That would hurt investors' portfolios of similar securities. The more noise they make now, the more they will discourage other countries from following Switzerland's example.

Swiss financial market regulator FINMA on March 23 defended its decision to impose steep losses on some of Credit Suisse's bondholders, saying the decision was legally watertight.

The Swiss regulator on March 19 wrote down 16 billion Swiss francs ($17.49 billion) of the lender's Additional Tier 1 debt to zero, even though shareholders received some compensation as part of a 3 billion Swiss franc rescue of Credit Suisse by rival UBS. Some Credit Suisse AT1 bondholders are seeking legal advice.

FINMA said the AT1 bonds contained contractual clauses which allowed them to be written down if Credit Suisse received extraordinary government support.

It also added that an emergency law, passed by Switzerland's Federal Council on March 19, authorised FINMA to order a borrower to write down AT1 capital.

FINMA Director Urban Angehrn said that "a solution was found on Sunday to protect clients, the financial centre and the markets".

European regulators on March 20 stepped in to say they would continue to impose losses on shareholders before bondholders - unlike the treatment of bondholders at Credit Suisse.