Upside down: when AT1 instruments absorb losses before equity

Highlights

• As demonstrated by the recent Credit Suisse episode, outside resolution, some Additional Tier 1 (AT1) bonds may be written down entirely before the wipe-out of Common Equity Tier 1 (CET1). This situation implies a transfer of value from holders of such AT1 bonds to shareholders.
• While the isolated write-down is feasible in many jurisdictions, unintended consequences associated with the use of this mechanism may lead authorities to only write down these bonds in resolution. This would effectively deprive them of their ability to absorb losses on a going-concern basis.
• Since the AT1 instruments were conceived for the purpose of absorbing losses on a going-concern basis, there may be merit in considering whether the current design of AT1 instruments remains fit for purpose or whether adjustments to the regulatory framework might be necessary.
• In addition, 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.