Silicon Valley Bank: Tales in risk management
14 March 2023
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28 March 2023RISK INSIGHT • 21 MARCH 2023
Haste is the Devil's Work
Matilde Espregueira, Head of Marketing
The merger of UBS and Credit Suisse marks the latest chapter in what has become quite a tumultuous month for the banking industry.
Last week, we examined the potential for market contagion following the collapse of Silicon Valley Bank. This weekend, global markets were yet again rocked by the news that UBS Group will take over Credit Suisse in a historic $3.23 billion deal. While the acquisition “is attractive for UBS shareholders,” according to UBS Chairman Colm Kelleher, he added that “as far as Credit Suisse is concerned, this is an emergency rescue.”
And, in their haste to push the deal through before Monday’s market open to secure financial stability and give confidence to global markets, regulators and the Swiss National Bank may find the deal they helped achieve has the opposite impact.
In today’s Insight, we investigate why this is the case and analyse the market’s initial reactions to the news.
Moral hazard and a weakening governance framework
There are three key issues underlying the UBS-Credit Suisse takeover. Firstly, Swiss authorities announced their intention over the weekend to change corporate laws to bypass a shareholder vote, enabling the deal to move much quicker. This is problematic as the foundation of a well-functioning market is trust in the legal framework and corporate contracts. Changing corporate laws—seemingly on a whim—sends the message that:
- Nothing is safe, as the rules of the game can be changed at any time.
- The systemic risk is far beyond what we imagined at the close of play on Friday.
- We should prepare for a profound impact on shareholder rights and perceptions of risk globally.
Secondly, the initial takeover price discussed on Friday was said to be 0.25 SFR versus a close price 1.86 SFR. One way to interpret this is that those involved in the deal expect Credit Suisse stock to fall by more than 85 percent in the coming days… Reassuring? Perhaps not.
And finally, UBS has requested a guarantee against any potential claims, lawsuits and fines that may arise from Credit Suisse’s past actions. Unless authorities yet again decide to change the laws to make any such fines and/or lawsuits invalid, Swiss taxpayers would find themselves liable to foot the bill.
From a (potential) risk of contagion to an (unintended) engineered contagion
Monday’s markets confirmed our earlier worries: hasty action has, indeed, led to unintended consequences.
Introduced in the wake of the Global Financial Crisis, additional Tier 1 bonds (AT1), also known as contingent convertible bonds (CoCo), are a type of debt instrument issued by banks that can be converted into equity if a specific strike price is breached.
Under the terms of the UBS-Credit Suisse merger, the value of Credit Suisse’s own $17bn worth of AT1 bonds was wiped out. This only served to further rattle global markets, with concerns relating to the hierarchy of investor claims. Indeed, AT1 bondholders would normally come before shareholders in the creditor pecking order.
Therefore, the decision to pay nothing to AT1 contingent bond holders while shareholders received 0.76 SFR per share is, once again, akin to changing the rules of the game after it has begun.
As a result, investors have adjusted their risk evaluation and portfolios by selling CoCo bonds, and prices have fallen as confidence in the debt instrument collapsed.
While still an evolving situation, when compared to the 2001, 2008, 2010 (EU) and 2020 crises, this current crisis seems to be the catalyst for the most change and damage to the financial framework due to decision makers’ reactions and haste.
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