Explainer: The Role of AT1 Bonds in Shaping New UBS Regulations After Merger
Understanding the Impact of AT1 Bonds on UBS Post-Credit Suisse Acquisition
ZURICH, April 23 (Reuters) – Additional Tier 1 (AT1) bonds are set to take centre stage when the Swiss parliament starts finalising rules for banking giant UBS in May, determining new capital requirements after the lender acquired fallen rival Credit Suisse in 2023.
Some lawmakers hope to rely on AT1 capital to support UBS’s competitiveness, though the government argues the loss-absorbing capacity of AT1 debt is too limited.
What is AT1 Capital?
AT1 is a form of regulatory capital ranked just below the highest-quality Common Equity Tier 1 capital, according to a definition by the Basel Committee on Banking Supervision.
Key Characteristics of AT1 Bonds
While CET1 capital absorbs losses immediately when they occur, AT1 bonds can be written down or converted into equity in a financial crisis.
UBS and AT1 Capital Holdings
Banks issue AT1 bonds as high-yielding perpetual debt aimed at institutional investors. UBS has about $20 billion in AT1 capital on its books, according to its latest annual report.
Why Does It Matter for UBS Regulation?
Switzerland is tightening its banking rules after the collapse of Credit Suisse left UBS as the country’s sole big bank.
Government Demands and UBS Response
The government’s chief demand, deemed excessive by UBS, is that the bank must fully back its foreign units with CET1 capital, which the lender estimates would require it to add about $20 billion in this expensive form of capital.
Lawmakers’ Proposal for AT1 Capital Use
Concerned about the bank’s competitiveness, Swiss lawmakers from different parties pitched a concession that would allow UBS to instead use AT1 capital to cover up to 50% of the capitalisation requirement for its foreign units.
The proposal could allow UBS to keep operating at around current CET1 capital levels while adding about $15 billion in less expensive AT1 debt, an idea the bank has called “more constructive”.
The proportion of AT1 debt allowed to meet the requirements will be “a potential game changer” for UBS, said David Benamou, chief investment officer of Axiom Alternative Investments.
How Safe is AT1 Capital in a Crisis?
Government officials and academics are sceptical, however. AT1 instruments can supplement CET1 capital, but are not an equivalent substitute, said Hans Gersbach, an economics professor at ETH Zurich.
Risks Associated with AT1 Capital
The main reason is that AT1 capital must be converted or written down to absorb losses, and to do so carries risks.
If the financial regulator intervenes while capitalisation is still high, it will be perceived as an official signal of distress and destabilise the bank. If that trigger point is too low, it may be too late to save the bank, critics say.
Expert Opinions on AT1 Security
“Any conversion of AT1 into equity in a crisis is likely to be the final blow to the bank,” said Aymo Brunetti, an economics professor at the University of Bern who has drafted previous Swiss banking regulation.
“If you want to make AT1 sufficiently secure, it ends up costing just as much as CET1.”
UBS Perspective on AT1 Instruments
UBS CEO Sergio Ermotti, however, said in a post on LinkedIn last month that AT1 instruments played a crucial role in stabilising Credit Suisse and enabling UBS to step in.
“The lesson from recent crises is not to remove these instruments, but to ensure they are robust and aligned with international best practice,” Ermotti wrote.
(Reporting by Ariane Luthi and Oliver Hirt; Editing by Susan Fenton)