AT1 bonds regain appeal for Asian investors

Additional Tier 1 bonds are seeing a resurgence in Asia following the Credit Suisse collapse, but now investors are looking for local insurances and systemically important banks to ensure the safety of the investments.  

Across Asia, AT1s have proven an attractive bond due to their higher rates and the comfort of investing in a recognised institution, like a global bank. Also called contingent convertible or coco bonds, the investments can be converted from bonds into equity, but only if certain conditions are met. With an in-built loss-absorption mechanism, AT1s are among the highest yielding bonds, due to the additional risks.

Yet the relative safety of AT1 bonds was dealt a shock with the collapse of Credit Suisse in 2023. The bank’s AT1 bonds, with a total value of $16bn, were wiped out as part of the merger between the bank and UBS. It also preferred the rights of shareholders over bondholders, going against established practice.  

Bondholders across Asia pursued legal action. In Hong Kong, investors stated that writing off the credit went against a bilateral investment treaty between Hong Kong and Switzerland, under the protected investments clause. And in Japan, retail investors have taken action against Mitsubishi UFJ Morgan Stanley Securities’ brokerage sale, stating they were not fully informed of the potential risks.

Legal action

Singaporean law firm Drew & Napier is representing two groups of Asian Credit Suisse AT1 bondholders in their action against the Swiss Financial Market Supervisory Authority, or Finma, and Credit Suisse at the Swiss Federal Administrative Court.  

At present, the firm is waiting for the Swiss court to serve the submissions filed by Finma and Credit Suisse to the appeals, along with direction on how the appeals will move forward.  

Benedict Teo, director at Drew & Napier, says that as part of the appeals, the firm’s clients are seeking to invalidate Finma’s directions to Credit Suisse on March 19 2023, with the bank reversing the write-down and cancellation of all AT1 bonds, and are calling for Finma to acknowledge obligations to bondholders with retroactive effect to the time before the write-down.

“The challenge rests on the [claim] that Finma’s exercise of its discretion to order Credit Suisse to write down the AT1 bonds was improper and/or invalid, and that the order to Credit Suisse to write down the bonds violated the principle of proportionality and was issued in bad faith,” says Teo. “It is also arguable that the conditions for a write-down under the terms and conditions of the AT1 bonds had not been met at the material time and thus the Finma order should be null and void.”  

Peter Kwon, partner in the commercial disputes team and lead of the Korea desk at law firm RPC, says he has seen disruption in the AT1 space, with the breakdown of the hierarchy of bondholders over shareholders having the biggest impact on investor trust.  

“The debt capital market sector is very sophisticated, and driven by principles and expectation. The AT1 bonds have made investors question if they can trust what they have been told. Until these questions are resolved, it is not good for the market as a whole. The most important point now is how the legal action is resolved,” says Kwon. 

Market response

With these investors waiting on the outcome of their legal actions, others are beginning to look at AT1s again with interest.  

While investors were initially spooked by the Credit Suisse write-down, regional regulators stepped up to reassure them. Both the Monetary Authority of Singapore and the Hong Kong Monetary Authority released statements to assure AT1 bondholders that their rights were ranked above those of shareholders, under local resolution frameworks.  

Willie Tanoto, director of Asia-Pacific financial institutions at Fitch Ratings, says: “In the wake of Credit Suisse, regulators around the region have reiterated that they intend to abide by the hierarchy of claims in liquidation. We have not observed structural changes in pricing spreads as a result of any perceived change in subordination or of loss severity.” 

These moves seem to have reassured Asian investors of the safety of the bonds. Speaking to The Banker, experts at Fitch Ratings from across the region have argued that there has been little impact to AT1 issuance in the domestic markets, with Australia, China, and South Korea all continuing to see interest in the bond.  

Successful issuances in the region since the Credit Suisse collapse include Y140bn ($932mn) of AT1s from SMBC. MUFG issued Y330bn of the bonds, triple the amount originally planned in response to investor appetite.

Shannon Kirwin, associate director of manager research at Morningstar, says the most popular trade over the past 12 months has been for Korean bank AT1s, which are considered the highest quality in the region. 

“Fund managers have noted that Asian AT1s were sold off indiscriminately in the Q1 2023 banking crisis, which afford some investors the opportunity to load up on what they saw as fundamentally sound Korean bank AT1s at attractive prices,” adds Kirwin.  

Further, investors are now looking for quality, favouring large, international banks — including those based in the US and Europe — for their investments, as they are under greater regulatory scrutiny, stress-testing, and higher capital requirements. 

Kirwin points to JPMorgan, Santander, and HSBC as attractive to investors, noting that when “portfolio managers are diving back into the AT1 pool, they seem to be doing so discriminately, with a strong preference for the highest-quality names”.