Swiss banks, the CET-S restrains the Federal Council on equity capital

Context

In brief

• CET-S slows down the 100% coverage in own funds for foreign subsidiaries
• AT1 bonds could cover half of the required coverage
• Currently the capital coverage for foreign participations is 60%
• UBS is the only systemic bank today affected by the measure

Key facts

• What: The Commission for Economics and Taxes of the Council of States (CET-S) amends the Federal Council's proposal on the coverage of foreign participations of systemic banks
• When: Debate and vote in Commission, announcement made in the evening via press conference
• Where: Bern, Federal Palace
• Who: CET-S, chaired by Erich Ettlin (Centre/OW); Federal Councillor Karin Keller-Sutter (Federal Department of Finance, FDF); Daniela Stoffel (State Secretariat for International Finance Matters, SIF)
• How: Vote with 10 in favour, 2 against and 1 abstention
• Original proposal: 100% coverage through Common Equity Tier 1 own funds (CET-1)
• CET-S proposal: Partial coverage through AT1 bonds (Additional Tier 1), with a revision of their functioning
• Current regime: Capital coverage of 60% for foreign participations

The Commission for Economics and Taxes of the Council of States (CET-S) has decided not to impose on the large Swiss banks a full 100% coverage in Common Equity Tier 1 own funds (CET-1) for their foreign subsidiaries, as proposed by the Federal Council within the framework of the revision of the banking law. The Commission prefers instead to allow about half of the coverage to be guaranteed through the so-called AT1 bonds (Additional Tier 1), hybrid instruments that offer a high yield but that can be converted into own capital or declared worthless in the event of difficulties of the issuing company — a mechanism that became known to the general public during the Credit Suisse affair.

The CET-S however requests a revision of the AT1 bonds, so that their loss-absorption effect is quicker. Measures are also envisaged aimed at preventing a bank from issuing these securities when it is already in a precarious financial situation, to avoid that the rescue instrument itself becomes a source of risk.

Own capital and consequences in case of failure to meet the requirements

The CET-S has also defined what happens if a bank should no longer be able to meet the 'hard' own capital requirements. In these cases, the obligation to suspend the payment of dividends to shareholders and the repurchase of shares will kick in. The bonuses paid to executives will have to be reduced, or even suppressed, depending on the extent and duration of the failure to meet the capital requirements. The decision was taken at the end of a debate held in the presence of Federal Councillor Karin Keller-Sutter, head of the Federal Department of Finance (FDF), and of Daniela Stoffel, head of the State Secretariat for International Finance Matters (SIF). The final vote recorded 10 in favour, 2 against and 1 abstention. The Commission did not have time to examine the state Public Liquidity Backstop mechanism, a topic that remains open.

Operational details

The reasons for the compromise: why not 100% CET-1

CET-S President Erich Ettlin summarized the philosophy behind the decision with an explicit formula: 'We want to strengthen the rules to better protect taxpayers, but also to ensure that the economy is not subjected to excessive regulation.' It is a balance between two needs: on the one hand, the protection of financial stability and public funds; on the other, the preservation of the international competitiveness of the Swiss financial center. Ettlin then made clear that this is 'a compromise — and not a gift to UBS': the purchase of AT1 bonds nevertheless involves costs, even though, he admitted, it is not clear how much these bonds would cost the number one Swiss bank. The bank had strongly opposed the original government proposal.

In concrete terms, the difference between the Federal Council's April proposal and the CET-S variant is not marginal. The Federal Council was asking that systemically important banks — today, in fact, only UBS would be affected — fully finance their foreign subsidiaries with Common Equity Tier 1 capital (CET-1). CET-S instead proposes that half of the coverage be met through AT1 bonds, a capital instrument that nevertheless has varying degrees of subordination and conversion risk depending on the issuing terms.

Comparison between the regimes: from 60% to the mixed scenario

To grasp the scope of the change, it may be useful to compare the regimes side by side.

The shift from a 60% regime to a scenario involving AT1 bonds directly affects the liability structure of Swiss systemically important banks, because AT1 bonds are subordinated securities that pay higher coupons than ordinary capital but offer, in return, the possibility of conversion into shares or write-down in the event of a crisis. For outside observers, this means that a larger share of the financing of foreign branches will be absorbed by bond investors rather than by shareholders.

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Key points

What changes in practice: possible scenarios

The CET-S text is not yet law: it is a Commission decision that must now go through the parliamentary process. The Commission itself stated that it did not have time to examine the Public Liquidity Backstop mechanism, pointing out that the dossier is still open.

Based on the factual data contained in the source, a few explicit scenarios can be hypothesized, presented as such and not as certain predictions:

Scenario A — A fully compliant systemic bank. A bank that meets all capital requirements can continue to pay dividends, repurchase its own shares, and award bonuses to executives without restrictions. No automatic obligation to issue additional AT1.

Scenario B — A bank falling below requirements. The obligation to suspend dividends and share buybacks kicks in; executive bonuses are reduced or, in the most serious cases, eliminated. The duration and extent of the reduction depend on how long and to what extent the requirements are not met.

Scenario C — Issuing AT1 while in difficulty. The CET-S explicitly provides measures to prevent a bank from issuing AT1 bonds when it is already in a precarious financial situation: in other words, the instrument designed to strengthen capital cannot be used as a last resort.

How to follow the evolution of the dossier

For those who live or work in Switzerland and want to follow the legislative process of the bank law revision, the operational steps are the following, based exclusively on the information contained in the source:

• Consult the CET-S Council of States press releases to know the text that the Commission will propose to the upper Chamber.
• Check the subsequent developments of the dossier, in particular the examination of the Public Liquidity Backstop, which the Commission declared it has not yet had time to examine.
• Follow the process in the Council of States and, subsequently, the procedure to eliminate divergences with the National Council, as well as the final stage at the Federal Council.

The concrete impact for Swiss taxpayers, as Ettlin stressed, is the stated objective of "strengthening the rules to better protect taxpayers": the CET-S decision moves in this direction, through a compromise that combines "hard" own funds (CET-1) and hybrid instruments (AT1) with automatic mechanisms suspending dividends and bonuses in case of breach of capital requirements. The final decision now lies with the Council of States.

To learn more about income and asset protection mechanisms in Switzerland, use the salary calculator.

Source: swissinfo.ch