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Swiss Public Liquidity Backstop Has Limited Implications For Hybrid Ratings

Switzerland has adopted a public liquidity mechanism based on the backstop first provided to Credit Suisse. The new law grants additional emergency and extraordinary liquidity assistance to systemically important banks (SIBs).

Following a consultation period, the final law was introduced on Sept. 6, 2023. It is largely identical to the draft version (see "Swiss Public Liquidity Backstop For Banks Comes With Strings Attached," published July 17, 2023, on RatingsDirect), except the SIBs must now pay lump-sum compensation in advance, regardless of whether the public liquidity backstop (PLB) is granted.

The law provides the Swiss Financial Market Supervisory Authority (FINMA) with codified powers, including the write-down or coupon deferral of AT1, if an SIB is using the PLB while it remains solvent.

S&P Global Ratings has considered whether the legal change should weigh on our ratings on Swiss SIBs' additional Tier 1 (AT1) instruments. In our view, the explicit legal linkage of bank liquidity stress to coupon nonpayment is novel among major banking markets. We think that the revision increases the possibility that we could apply additional notches to our ratings on these instruments if a Swiss SIB faced or was at risk of facing an extraordinary liquidity stress scenario.

We could widen the notching on Swiss SIBs' AT1 instruments by deducting a notch or more under step 2b of our hybrid methodology (see "Hybrid Capital: Methodology And Assumptions," published March 2, 2022) if there were signs that an SIB was at heightened risk of significant stress, either on liquidity or capital.

Our view on the legal change indicates the following:

  • The write-down and coupon nonpayment of AT1 instruments is not mandatory upon use of the PLB by an SIB. We consider FINMA's decision to enforce a write-down on Credit Suisse's AT1s as a notable precedent, but we do not conclude that FINMA would automatically follow a similar approach in the future should other Swiss SIBs make use of the PLB. Regulatory interventions on AT1 instruments remain at the discretion of FINMA and subject to broader legal principles, such as the principle of proportionality.
  • The new law only makes explicit a risk that we see as already inherent in AT1 instruments. We consider that AT1s are deeply subordinated instruments with discretionary coupon payments and subject to potential regulatory intervention in case of stress. Our notching approach for such AT1 instruments--typically rated four notches below the bank's stand-alone credit profile (SACP) for standard low-trigger AT1 instruments--reflects this view. The explicit inclusion of a legal basis linking AT1 write-down or coupon conversion and liquidity stress is unusual, but we do not see it as a material increase in the structural default risk already reflected in the ratings on Swiss SIBs' AT1s.
  • Even if stressed Swiss SIBs have not accessed the PLB, they might anyway become nonviable and so default on their AT1s. Whether this stress stems from capital or liquidity or both, it can be difficult to turn around a deeply stressed bank and avoid nonviability. In such a scenario, the PLB may not have been accessed--either because access was not requested, or because the request was not granted.

Similar Measures In Other Countries

We consider that Switzerland's approach might not materially differ from foreign authorities'. Authorities in other markets have taken emergency actions that led stressed banks to default on hybrid instruments, including AT1s. While regulators do not take lightly the decision to require coupon nonpayment, it is possible that even outside Switzerland regulators may balk at the idea of allowing discretionary distributions to investors, such as the payment of AT1 coupons, if a bank benefits from extraordinary liquidity support under the terms of which, for example, the government faces substantial credit risk.

The SACP is the usual starting point for our ratings on bank hybrids. If a bank's creditworthiness weakens--whether this is due to liquidity, capital, or other concerns--then we would lower our assessment of the SACP, and therefore of related issue ratings, including on the bank's hybrids. If we see additional risks for specific instruments, we use step 2b under our hybrid methodology to notch down those issue ratings further. Should a Swiss SIB face extraordinary liquidity stress in the future, the existence of the new Swiss law will likely increase the possibility that we apply additional notches to our ratings on a Swiss SIB's AT1s.

Related Criteria

Related Research

This report does not constitute a rating action.

Primary Credit Analyst:Lukas Freund, Frankfurt + 49-69-3399-9139;
Secondary Contacts:Giles Edwards, London + 44 20 7176 7014;
Salla von Steinaecker, Frankfurt + 49 693 399 9164;
Anna Lozmann, Frankfurt + 49 693 399 9166;

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