Prof. Dr. Yvan Lengwiler

Finanzmärkte

Research Topic
The March 2023 forced merger of Credit Suisse with UBS, coupled with the unprecedented
writedown of Credit Suisse‘s Additional Tier 1 (AT1) bonds, marked a watershed
moment in global finance. This event upended the risk hierarchy in bank
capital structures that many investors had believed to be true and revealed critical
gaps in investors‘ understanding of AT1 instrument risks. Our research examines
the fallout in the global Contingent Convertible (CoCo) bond market, encompassing
both AT1 and Tier 2 (T2) bonds.

Description of the Problem
CoCo bonds were introduced after the 2008 financial crisis to strengthen bank capital.
They now constitute a $250 billion global market, with Switzerland ranking
among the most prolific issuers. AT1 CoCos are designed as going-concern capital,
intended to recapitalize a bank by converting to equity or writing down when triggered,
helping recovery before nonviability. In contrast, T2 CoCos act as gone-concern
capital, triggered only after regulatory declaration of non-viability, indicating
recovery has failed or is no longer feasible, potentially leading to bank resolution.
However, the March 2023 Credit Suisse merger exposed a disconnect between regulatory
intentions and market perceptions. The complete write-down of its AT1
bonds stunned investors, revealing a gap in how the risks of these instruments
were assessed. The resulting market turmoil highlighted a consistent undervaluation
of AT1 risk prior to the event. This compels a fresh look at CoCo bond valuations,
investor risk models, and regulatory responses.
Divergent regulatory approaches have further complicated the landscape. While
Swiss authorities treated AT1 bonds as true going-concern capital, EU regulators
have effectively transformed them into gone-concern capital by mandating their
write-down only after shareholders are wiped out. This policy shift not only alters
AT1 risk profiles but also has profound implications for T2 bonds. By potentially
hastening the path to bank resolution, it increases the risk for T2 bondholders, as
resolution processes often involve asset devaluation through mechanisms like fire
sales, eroding the safety margin for all senior debt.
Importance, Usefulness and Novelty of the Project
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this project will generate insights to help managers balance promoting a firm’s
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partnerships (e.g., white-label production in the nutrition and supplements space).
These regulatory divergences create a complex risk landscape where both AT1 and
T2 bonds may carry different implicit risks across jurisdictions, despite maintaining
their relative positions in the capital structure. This situation necessitates a comparative
analysis of AT1 and T2 pricing across jurisdictions, as well as an assessment of
the CoCo bond market‘s recovery since the Credit Suisse event, particularly from a
Swiss perspective, given its direct impact on banks‘ cost of capital.

Objectives
a. Were AT1 coco bond risks globally underpriced before the Credit Suisse
event, and how have risk perceptions changed since?
b. How have different CoCo bond types, varying in regulatory status, trigger
levels, and conversion mechanisms, responded to the event
c. and recovered since?
d. How has the EU‘s policy, effectively turning AT1 bonds into gone-concern
capital, impacted the risk perception and pricing of both AT1 and T2
bonds in the EU compared to Switzerland and other jurisdictions?
e. Has the Credit Suisse event led to a reassessment of the effectiveness of
CoCo bonds in preventing bank failures, and how might this impact
future bank capital regulations?

Importance, Usefulness and Novelty of the Project
This research aims to deepen our understanding of risk pricing in complex financial
instruments and the influence of regulatory frameworks on these markets.