By Colin Clunie, head of EMEA operations at Clearwater Analytics
Two years ago, the world witnessed the dramatic fall of a historic banking institution. UBS stepped in at the behest of the Swiss financial authorities, swallowing up Credit Suisse. Several years of scandals had eroded investor confidence in the bank, forcing the shotgun merger.
In amongst the chaos, a pocket of investors was caught out as the AT1, or ‘co-co’ bonds that had been issued by Credit Suisse were written off by the Swiss authorities. Some $17bn in losses and 2 years later, this decision is still being challenged in the courts.
In the time since, market demand for AT1 bonds has recovered and yields are elevated compared to pre-2023 levels, making them a good money-making instrument.
However, to safely invest in these bonds, investors need to ensure they recognise the unique considerations from a valuation, accounting, and risk perspective, and invest in systems that cater for them accordingly.
AT1 bonds are a class of hybrid debt instruments issued by banks to strengthen their capital buffers, sitting between equity and debt in their capital structures. They are designed to absorb losses in times of financial distress, typically ranking above common equity, but below all other forms of debt in a liquidation scenario.
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This makes them inherently riskier than other forms of debt. Compared to conventional bonds, the unique, hybrid nature of AT1 bonds introduces complexities in valuation, accounting, and risk management.
These include the fact that they can be converted into equity or entirely written down if a bank’s capital ratio hits a critical level, that they trade with higher volatility and lower liquidity than senior bank bonds, and crucially, that they can be cancelled at the discretion of regulators or banks. All these factors have significant implications for their risk profiles, and therefore how an investor treats them within their wider portfolio.
For example, many risk models struggle with AT1 bonds due to their contingent nature. Stress testing AT1s requires a vast range of varied data linked to the perceived chances of regulatory intervention, bank-specific distress scenarios, broader market contagion, and other factors that could impact the banks that issue them.
Further, because of variations in contractual terms, standardised reporting across different issuers and jurisdictions is made far more difficult, particularly if this contractual data comes in an unstructured form.
What the Credit Suisse AT1 controversy highlighted was that investors need better transparency when engaging with these instruments. Transparency and more effective risk management can only be achieved through improved data standardisation, and improved data availability through the investors’ different teams, from front-to-back-office.
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Confidence has returned to the AT1 bond market, shown by higher levels of market demand recently. Yields have risen, largely as a response to what happened with Credit Suisse, and the associated banking stress experienced in early 2023. Set against a broader downturn in market sentiment linked to geopolitical factors, these bonds could appeal as a way of ensuring strong yields for investors.
However, truly restoring confidence in the AT1 market will require more than increased investor appetite, regulatory reforms, or yield premiums – it demands a fundamental shift in how these instruments are understood, monitored, and managed, from a data perspective.
Re-engaging with AT1 bonds requires a higher level of data clarity and analytical rigour beyond traditional fixed income instruments. Not only does their structural complexity within bank capital frameworks underscore the need to prioritise data management infrastructures, but the instrument’s sensitivity to shifting market sentiment on valuation and liquidity make having accurate, real-time data not just best practice, but a strategic necessity.
Without enterprise-grade infrastructure capable of standardising, aggregating, and disseminating all the information required throughout the business, investors risk repeating history. These hybrid bonds are unique and require an approach that recognises that. Only by putting the data first, can investors be confident of reaping the rewards that these high yielding debt instruments offer.