UBS Nudging Swiss Capital Debate Toward a Cheaper Compromise

(Bloomberg) — Swiss lawmakers are focusing on a possible compromise in the debate over the regulation of UBS Group AG, which would potentially make it less expensive for the bank to meet the government’s $20 billion capital demand.

A parliamentary committee is zeroing in reforms to convertible bonds known as Additional Tier 1 capital. The changes would effectively impose losses on the instruments early on in a crisis, something that didn’t happen during Credit Suisse’s collapse three years ago.

Since then, Switzerland has been struggling to find a way to make its sole global bank crisis-proof, with the government’s approach centering on the substantial increase in equity capital. UBS executives have pushed strongly against that, arguing it will make them uncompetitive.

The bank has itself subtly steered the debate toward the solution that uses more AT1 debt — which has the advantage of being a cheaper form of bank funding.

If a robust Swiss reform to AT1s can emerge, lawmakers are more likely to back allowing UBS to use a bigger share of the instruments to reach the capital increase being proposed by the government, according to lawmakers and academics.

The compromise requires tweaking the hybrid capital in a way that would boost its ability to offset losses like equity capital does now — without rendering it useless as an asset class.

In June, a UBS-commissioned study was published in an academic journal on AT1 reform. In it, authors including Basel University Professor Yvan Lengwiler and lawyer Rolf Watter — who has previously represented UBS — argued that AT1 bonds can be made more useful much earlier in a stress situation.

The main tenets of the paper’s argument was then submitted to the upper house’s Economic Affairs and Taxation Committee shortly before the original vote on UBS capital proposals was due earlier this month. The vote was postponed and is now expected on Aug. 31, with AT1 reform a major factor in the debate.

UBS shares were little changed on Thursday.

“The key question is: Are AT1s a viable option, and if so, to what extent can they be used? We’ll address that on August 31,” said Erich Ettlin, a centrist lawmaker and president of the committee.

Until now, UBS has said little about what its desired outcome from the parliamentary process would be. No decisions from parliament are likely to be final until next year at the earliest.

“As stated in the response to the Federal Council’s consultation last year, UBS, alongside a broad range of other stakeholders, supports the strengthening of AT1 instruments, provided this is aligned with international standards,” UBS said in a statement to Bloomberg. “However, this is only one element of a broader reform package and should be considered in the context of achieving a targeted, proportionate and internationally aligned outcome as opposed to the Federal Council’s extreme proposals.”

AT1s were born in the aftermath of the Great Financial Crisis as a way to increase a bank’s loss-absorbing capacity while retaining a lower cost than equity capital. UBS is a substantial player in AT1s globally, and the debt that it has issued accounts for some 7% of the $286 billion European market.

A global discussion over reform of the AT1 market has been taking place since 2023, focused on the question of whether the debt can reliably serve as capital in a crisis where the bank survives — instead of being used in the case of resolution.

The Credit Suisse crisis, where the bonds didn’t serve any loss-absorbing function until after the bank had to be rescued by UBS, has cast doubt on their role generally. Some $17 billion of AT1 debt was written off as part of the package, resulting in multiple legal challenges.

Spreads for UBS AT1 debt have widened on occasion due to the uncertainty around Switzerland’s regulation of the debt. And investors demanded a higher yield for investing in Swiss AT1s in particular after the 2023 write down.

Swiss Finance Minister Karin Keller-Sutter has said the government intends to wait and see how the global debate develops before backing changes at home. Whether, and how, Swiss AT1 reforms would interconnect with the global market remains unclear.

“The goal is to have internationally aligned AT1s—that is, AT1s that are accepted in an international context. Otherwise, they’re useless,” Ettlin said. “If the market doesn’t accept them, then everything has to be backed by equity capital.”

Surprise Suggestion

Two years ago the Swiss government first proposed making UBS back substantially more of the value of its foreign units — such as its US-based investment bank — with the best-quality equity capital, or CET1. It later specified the level should be 100%. In theory, that makes it easier to sell units should that ever be needed in a crisis. UBS has argued that the proposals will make it uncompetitive against its peers.

The Swiss National Bank, which plays a role in financial regulation, weighed in on the debate late Wednesday. Vice President Antoine Martin challenged UBS’s view that higher capital requirements make the bank less competitive. In a speech, he reiterated the central bank’s view that fully backing the foreign units with CET1 would make the Swiss financial center more resilient.

Ultimately parliament, not the government or the SNB, will have the final say on the regulation.

AT1 debt saw a surprising revival in the political debate last December, in a proposal from the center-right. That helped send the bank’s stock price to a 17-year high. But the plan met with rebuttal by the Swiss government, on the basis of the doubts over AT1s suitability as “going concern” capital.

“The only hard currency is hard equity capital,” Keller-Sutter reiterated earlier this week. “We have examined the question — for example, 80% and 20% AT1 — but given international developments and legal uncertainty, we decided not to put forward this proposal because in going-concern, only hard equity is loss-absorbing.”

Yet the proposal has now returned, with amendments. An op-ed in the Swiss newspaper NZZ authored by Lengwiler and Watter was published in June and made the same arguments as their academic paper. It was later cited by lawmakers as a basis for discussions in parliament.

In response to questions from Bloomberg, the study’s authors said UBS had no influence on the paper’s conclusions, and the intention was to make proposals to repair the AT1 instrument stemming from independent research.

UBS displays a link to the Lengwiler paper on its web page dedicated to materials supporting its view on the Swiss debate.

“When selecting the authors for the study it commissioned on AT1 instruments, UBS retained renowned experts in financial market regulation,” UBS said in the statement, noting Lengwiler is the former chair of the Federal Council’s Expert Group on Banking Stability.

New Trigger

The debate saw its most recent twist earlier this month when Lengwiler and another Basel University professor, Corinne Zellweger-Gutknecht — who has previously conducted research for the government — put forward the joint proposal to the upper house committee meeting on Aug. 11.

Zellweger and Lengwiler argued that AT1s should come with a first stage built in, to help manage a loss-making bank before it reaches the point of collapse. When a firm drops below its regulatory capital requirement, coupons — along with shareholder dividends and management bonuses — should be suspended, they argue.

That phase would come long before the standard trigger point for AT1 debt where they would normally get converted into equity. The academics propose a second stage where, if the initial one doesn’t work, the bank offers voluntary conversion to equity for AT1 holders while it conducts a rights issue.

The committee may yet reject any AT1 compromise and focus on other solutions. Alternative proposals deviating from the government’s original demand would simply lower the percentage which UBS has to cover. There’s also the possibility that lawmakers back the government plan.

Independent of what the panel will vote for, it appears likely that their decision will set the tone for the rest of parliament’s deliberation of new capital rules for the bank, even as the process won’t finish before next year. Due to the complexity of the matter it’s unlikely that any other body of lawmakers will go for another in-depth discussion of how requirements should look and what role AT1s may have in them.

–With assistance from Tasos Vossos, Noele Illien, Helene Durand and Steven Arons.

(Adds Keller-Sutter comment.)

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