Upside down when AT1 instruments absorb losses before equity

The recent Credit Suisse episode has demonstrated that Additional Tier 1 (AT1) bonds may be written down entirely before the wipe-out of Common Equity Tier 1 (CET1). This could lead to a transfer of value from AT1 bondholders to shareholders.

While the isolated write-down of AT1 bonds is feasible in many jurisdictions, it may have unintended consequences, such as deterring investors from buying these bonds. This could effectively deprive banks of the ability to absorb losses on a going-concern basis.

Given the potential for market misperceptions regarding the functioning of AT1 bonds, authorities may wish to consider whether there is merit in pursuing regulatory work aimed at increasing the transparency and disclosure of AT1 instruments' characteristics.

The FSI Briefs No 21 aims to contribute to this debate by analyzing a sample of AT1 instruments issued under various legal frameworks with a view to identifying the potential of isolated writedowns.