Despite regulator claims, bank rescues have always been political

David Orbay-Graves

24 March 2023•4 min read

Regulators in the UK and Europe moved fast to reaffirm their commitment to the normal investor hierarchy in bank resolution — CET1 behind AT1s, AT1s behind T2 instruments — after it emerged Credit Suisse’s takeover would zero CHF 16bn worth of AT1 bonds, despite equity owners receiving CHF 3bn.

Despite outwardly professing support for the Swiss authorities’ actions, the tacit message from the UK and European regulators was crystal clear: ‘Don’t worry, we’d never do what the Swiss have just done.’ It’s just the thing jittery AT1 bond investors wanted to hear, but is it true?

Well, as the Bank of England noted in its press release, the hierarchy was followed during the recent SVB UK collapse. Meanwhile in Europe, the case of Spain’s Banco Popular — the first major test case for AT1 write-down — saw the equity fully wiped alongside the AT1s (and Tier 2 notes, for that matter), again in line with the hierarchy.

So far, so good – UK and European bank resolution working as advertised (or at least, as understood by most of the market prior to the Credit Suisse debacle).

But let’s turn back the clock to 2016, and cast our attention eastward. Emerging market investors remember the nationalisation of Ukraine’s PrivatBank all too well. The bank, it was revealed, had been subject to an alleged multibillion-dollar fraud at the hands of its soon-to-be-former oligarch owners.

The Ukrainian state recapitalised the bank to the tune of $5.5bn and bondholders were wiped out, including both senior and subordinated loan participation notes (a bond-equivalent structure frequently used by Russian and Ukrainian issuers).

The nationalisation was approved of by the likes of the World Bank and the IMF which appear to have been keen to support Ukraine, still reeling from the annexation of Crimea and its recent sovereign restructuring.

Nothing in particular to write home about so far: nationalisations of oligarch piggy banks are 10 a penny in emerging markets. Where it gets interesting, in regard to the UK’s commitment to creditor hierarchy, is that the Bank of England was asked to recognise the resolution.

Why did the Ukrainian authorities need the UK’s stamp of approval? The linkage between PrivatBank and the UK was slim, but the bonds were issued by a UK-domiciled orphan SPV and governed by English law.

The bailed-in senior bondholders had launched arbitration proceedings against PrivatBank in the London Court of International Arbitration (LCIA). And the LCIA eventually ruled that bondholders not related to the former owners should indeed be repaid — but only if the Bank of England refused to recognise the Ukrainian resolution process.

In a move that dismayed bondholders, the Bank of England announced that it would recognise the resolution in 2021 — the first (and only) third-country recognition it has ever granted. As an aside, it was Quinn Emanuel that represented PrivatBank in its ultimately successful LCIA arbitration, the same law firm that is now seeking to corral (only 9fin clients can access) Credit Suisse AT1 bondholders into a group to litigate against their bail-in.

While no one truly doubted the need for PrivatBank’s nationalisation, bondholders fielded some fairly compelling arguments that they had been hard done by. Notable in the current context, bondholders argued they were unfairly categorised as a related-party to PrivatBank, by virtue of the orphan SPV having been established by the bank.

As such the senior unsecured bonds were folded into a related-party tier of creditors in the Ukrainian resolution process, which ranked junior to senior unsecured creditors. Commodity trader Cargill, a seemingly pari passu senior unsecured creditor to PrivatBank, dodged the bail-in. For its part, the LCIA accepted the bondholders’ argument on seniority, ‘looking-through’ the SPV to assess whether the ultimate holder of the LPNs were related or not.

The Bank of England was unmoved. It is worth noting that the Bank of England’s threshold for recognition of a third-country resolution is lower than needed for a resolution it conducts itself — recognition requires the third-country process to have been “broadly comparable in terms of objectives and anticipated results” to a resolution carried out directly under the UK regime.

Further frustrating bondholders, the Bank of England recognition was an administrative decision, rather than a court judgment (as would be the case in the recognition of a foreign corporate restructuring under the Cross-Border Insolvency Regulations), meaning a detailed rationale for the recognition was not published. What detail did emerge was largely through journalistic reporting.

Moreover, there is limited scope to challenge an administrative decision — bondholders briefly considered bringing a judicial review, but ultimately decided against this route.

Of course, the factual matrix in the case of PrivatBank was very different to that of Credit Suisse (the PrivatBank notes were senior unsecured and did not feature bail-in language, were governed by English law, and the equity was entirely wiped out under the Ukrainian resolution process).

There is no indication that UK recognition would be needed to discharge the Credit Suisse AT1s, and a source close to the Bank of England told 9fin on Monday that no recognition request had been received by the UK central bank. All of the bailed-in Credit Suisse AT1s for which documentation is available online are governed by Swiss law.

Nonetheless, PrivatBank serves as a salutary reminder that, when it comes to bank rescues, political expediency is — and always has been — just as important a consideration as the resolution framework as it is generally understood. Emerging market investors have long been alive to this fact, it seems developed market investors are only now learning the lesson.