The first Basel III-compliant tier one subordinated
bonds to incorporate a write-off feature have launched in the
Swiss market, marking a new milestone in post-crisis regulatory
The bonds, issued by Zürcher Kantonalbank (ZKB) on
January 18, look set to provide a template for institutions
seeking an alternative to convertible equity instruments.
Theres no provision in Swiss
law stipulating I unilaterally renounce my right to
claim the principal, if a trigger event happens,
said René Bösch of Homburger in
Switzerland, the lead partner on the deal .
We had to embed a provision that was structured as a
contract so that a trigger event would lead to a write-down and
the claim will disappear.
The Basel Committees
rules state that qualifying capital securities must
include a mechanism to force investors to absorb losses. This
is achieved either by converting into equity or
permanently writing off the principal amount of the bond upon
occurrence of a so-called non-viability trigger.
Credit Suisses 2011
contingent capital bonds included the equity conversion
mechanism. The second write-down method was untested until
Questions over how the
write-off functionality would work meant lawyers had to examine
the structure closely to ensure the bonds would be Basel
III-compliant while still appealing to investors.
It was a design
issue, said Bösch. We
had to clarify on what basis to measure whether there is a
trigger point and what the sequence of events leading to it
The main issue centred on establishing when government
support would constitute state aid, thereby
triggering the write-down mechanism, and when it would be
commercially feasible and therefore not lead to a triggering
event. For example, if the
government wants the banks to expand and injects capital, this
will not give rise to a trigger. But, if the circumstances are
so extraordinary that there is no commercial reason other than
just keeping the bank afloat then this would lead to a
For the capital to risk weighted asset trigger, the
annual and semi-annual financial statements were used to
provide a reliable accounting basis.
A further challenge with the subordinated debt was
accommodating all the dividend discretion features.
Working with no precedent focused attention on drafting
techniques. We spent a lot of time finding the exact
language and making the terminology as precise as we could to
produce a robust structure, added Bösch.
To do this, lawyers started out with plain-vanilla
bond documentation then weaved in the particularities of the
Homburger acted as sole transaction counsel to ZKB and UBS.
The bonds were placed through UBS and ZKB as joint lead
Moodys credit opinion on ZKB was issued on