The Credit Suisse Crisis and International Law: Time to Embrace Regime Complexity?  

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There is a quasi-existential urge among international lawyers to present international law as salient whenever the “opportunity” of a crisis presents itself. Judge Charlesworth has famously lamented this urge because it distracts us from the subtle ways in which international law may deliver everyday justice. Yet, when it comes to financial crises, this “quest for international law” has been less anxious. While technical contributions by financial law experts were offered in specific issue-areas following the global crisis of 2008, an attempt to catalogue and present a systematized understanding of the universe of international rules governing financial crisis response has yet to be made.

If international law is indeed a “discipline of crisis”, and if international lawyers have in the past been able to systematize climate change law and jus in bello, why has “financial crisis response law” not seen the same fate? And what are the risks of this lack of systematization? This note shares the author’s brief thoughts on these two questions, prompted by the ongoing banking crisis in Switzerland.

The risks of an undertheorized regime complex

Stephen Krasner has seminally defined regimes as sets of “principles, norms, rules, and decision-making procedures around which actors’ expectations converge in a given area of international relations”. Based on this definition, international trade law, for instance, can be thought of as a regime. Expectations around it indeed (generally) converge, largely due to the centralization of the WTO system. The rules governing financial crisis response, on the other hand, do not meet Krasner’s definition, having emerged from distinct bases of authority and lacking linearity. Since, nonetheless, they happen to affect the same issue-area (some by design and others by “accident”), we can still approach them as a “regime complex”, namely as an array of “nested, partially overlapping, and parallel international regimes that are not hierarchically ordered”, by Karen Alter and Sophie Meunier’s definition.

The disadvantages of regime complexes vis-à-vis centralized systems (or even “complex adaptive systems”) are obvious: being inconveniently located, norms in such complexes are hard to systematize and anticipate. Thus, when a crisis hits, crisis “responders” have no clear reference framework, such that their policy choices are bound to be “informationally imperfect”. Crisis “responders” may then miss the opportunity to leverage useful tools and mitigate costly risks, and may even act with a limited sense of legal accountability. Moreover, naturally, complexity frustrates coordination; for instance, given the absence of a formal global network of bank resolution authorities, consultations between such authorities across different jurisdictions during a restructuring will tend to be limited, leading to increased contagion, reputational and spill-over risks. The reaction of some central banks to the Credit Suisse (“CS”) deal, discussed further below, is a case in point.

To mitigate these risks, issue-areas governed by regime complexes should be “unitarily” theorized. If dispersed constitutive rules and regimes are mapped and the interactions between them are properly understood, crisis “responders” can indeed make better-informed decisions against more predictable frames of reference. Yet, regrettably, in matters of financial crisis response, no decisive efforts in this direction have been made, besides certain attempts by C. Randall Henning (see e.g. here). This could be because, as noted by Federico Lupo-Pasini, “in the international law of finance what really matters is not the protection of social goals, but rather the safeguarding of national interests”. As such, “the logic of stability often gives way to […] the logic of financial nationalism”. Whatever the actual reason, the risks of the lack of systematization seen in the regime complex for financial crisis response are significant. Could the CS crisis prompt a “rethinking moment” in this sense?

The Credit Suisse crisis: the regime complex for financial crisis response at play

Between 18 and 19 March 2023, UBS and CS negotiated a takeover of the latter by the former, whereby CS’ shareholders would receive one UBS share for every 22.48 CS shares held. In addition to having previously made CHF 50 billion in Emergency Liquidity Assistance (“ELA”) available to CS, the Swiss National Bank undertook to facilitate the deal by lending up to CHF 100 billion to UBS and making a further CHF 100 billion available via a public liquidity backstop. The latter amount will be explicitly guaranteed by the Swiss government, which, in addition, has promised to absorb up to CHF 9 billion in potential losses from the takeover.

As announced by the Swiss Financial Market Supervisory Authority (“FINMA”), “[t]he extraordinary government support will trigger a complete write-down of the nominal value of all AT1 debt of [CS] in the amount of around CHF 16 billion”. This decision marks a departure from the typical liquidation hierarchy, according to which equity must be absorbed before AT1 bonds; it may, as a result, cause an increase in the risk profile and price of AT1 bonds worldwide. Creditors and law firms have announced litigation plans as a reaction to this decision, while some stakeholders appear to have even suggested that the decision was made to purposefully favour CS’ anchor shareholders. Importantly, the deal will also result in a state-sponsored and overconcentrated Swiss banking market, in addition to making UBS the world’s second largest wealth manager.

From a contractual standpoint, the deal’s legality is unclear. The bonds included a clause according to which they could be written down in a “viability event”, while their prospectus can be construed to suggest that FINMA was not required to follow an order of priority. Things are equally unclear from a constitutional perspective. While shareholders should have normally been given six weeks to consult on the acquisition, the authorities bypassed the applicable voting procedures through an emergency law enacted on the day of the deal.

The above-described deal faced, could have faced, or might yet face, constraints stemming from the below international rules and regimes:

– To begin with, Switzerland’s bank resolution framework is generally modelled on the FSB’s Key Attributes of Effective Resolution Regimes for Financial Institutions (“Key Attributes”). Among the “twelve essential features that should be part of the resolution regimes of all jurisdictions”, the Key Attributes list feature No. 5.1, which states that “equity should absorb losses first, and no loss should be imposed on senior debt holders until subordinated debt (including all regulatory capital instruments) has been written-off entirely”. Feature No. 5.2, moreover, provides that “[c]reditors should have a right to compensation where they do not receive at a minimum what they would have received in a liquidation”. The jury is still out on whether the takeover complied with these safeguards, but the uncertainty itself appears to have already dealt a blow to Switzerland’s reputation, with the ECB, EBA and SRM rushing to reassure investors that, unlike Switzerland, they will provide these safeguards when and if needed. Importantly, the EU resolution framework closely mirrors the Key Attributes.

– Given the strength of the Swiss economy, a Stand-by Arrangement with conditionalities under Article V(3) of the IMF’s Articles of Agreement (“AoA”) is unlikely. It must be recalled, however, that the IMF has intervened in banking crises in small yet high-income European nations with oversized banks in the past (see Ireland, Iceland and Cyprus), and certain aspects of bank restructuring in these cases had to abide by conditionalities.

– Separately, Article IV(1) of the IMF’s AoA requires members to promote “a stable system of exchange rates” (a notion which the IMF construes to comprise “systemic stability”), as well as “stability” more generally, “by fostering orderly underlying economic and financial conditions”. To “oversee the international monetary system in order to ensure its effective operation”, the IMF conducts regular surveillance in relation to these obligations (under Article IV(3)(a) of its AoA), in addition to performing less formal scrutiny through “country reports”. One such report noted in 2019 that, in Switzerland, “hardly any information on ELA requirements and procedures [was] publicly available” at the time, while also urging Switzerland to “ensure that some guidance is given regarding two elements [of bank restructuring]: triggers; and type of measures”.

– As described above, the UBS-CS deal entailed considerable public support, notably in the form of massive ELA, guarantees and photographic legislation. The deal could thus face scrutiny under extra-territorial competition rules, as well as non-discrimination provisions in Free Trade Agreements (“FTAs”) and International Investment Agreements (“IIAs”), especially since some foreign investors were reportedly interested in an orderly acquisition of CS. Since the deal could also constitute a de facto limitation on the number of financial service suppliers, services chapters in FTAs, or even the WTO’s General Agreement on Trade in Services, could also be theoretically triggered.

– Holders of AT1 bonds may seek redress under IIAs, arguing, e.g., indirect expropriation or a violation of the FET standard, in addition to pursuing litigation in the jurisdictions of their bonds. Though an unlikely avenue, the ICJ also remains available by means of diplomatic protection (note that Switzerland has made a unilateral declaration accepting the ICJ’s jurisdiction as compulsory). Lastly, bondholders may seize the ECtHR citing their rights to non-discrimination and peaceful enjoyment of possessions. Investment protection disputes before human rights courts abound.

A rethinking moment? Proposal for a system-like conception of the regime complex for financial crisis response

As seen above, a set of regimes with distinct bases of authority and following no hierarchical structures, yet governing a common issue-area, affected, could have affected, and might still affect, the situation in Switzerland. Swiss authorities could have benefitted from a collective understanding of the different international norms they could have leveraged, as well as the norms that could have constrained their actions.

It is, of course, too early to assume that the Swiss authorities, which are highly sophisticated, ignored certain sources of international legal constraints or failed to consider all international legal tools they had at their disposal. It is equally early to tell whether the UBS-CS deal will generate reputational and fiscal harm through multi-jurisdictional litigation/arbitration. But if it does, we must understand that an “international law of financial crisis response” exists, even if “just” in the form of a regime complex, and that its conception as such could have contributed to a better outcome. We must not wait for a generalized crisis (which, by some estimations, might not be far) to form this understanding; rather, we should embrace the CS crisis itself as a “rethinking moment”, prompting us to systematize, and “unitarily” approach, the “international law of financial crisis response”.

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Jeremy McBride says

March 29, 2023

Although the peaceful enjoyment of possessions ought, in principle, to be relevant, Switzerland has only signed but not ratified the guarantee of this right in Protocol No. 1 to the ECHR. However, as in the Al-Dulimi and Montana Management Inc. case (5809/08), there might be an access to court issue if it is not possible in the Swiss courts to challenge the action taken