What are AT1 bonds and why do they matter?

This article is brought to you thanks to the collaboration of The European Sting with the World Economic Forum.

Author: Dr. Bob Maughon, Executive Vice President, Sustainability, Technology & Innovation and Chief Technology and Sustainability Officer, SABIC

• Bank rules were strengthened in the aftermath of the 2008 global financial crisis.
• Banks are now required to hold more capital to provide a layer of protection when they run into trouble and prevent taxpayers from bailing them out.
• This capital is made up of different assets, including Additional Tier 1 bonds, or AT1s.

When a bank goes bust, who pays?

It’s a hot topic at the moment, and one that is front of mind for people around the world, as financial market turmoil roils banks’ stocks. The fallout and loss of trust in the system has prompted several institutions to need help.

Banks are an integral part of all our daily lives, they take deposits, hold savings, make loans, and support many aspects of the economy as they do so. Making sure they’re functioning in a responsible and stable way is essential for modern life and critical for society.

Because of their wide-ranging roles, when banks run into trouble or fail, they set off a chain of events that can have broad negative consequences for whole countries or even regions. Those risks are higher against a backdrop of economic uncertainty and turmoil, as highlighted by the World Economic Forum’s latest Chief Economists’ report.

Strengthening banks’ reserves

After the bank failures that took place in the 2008 financial crisis, many aspects of bank supervision were strengthened, reflecting the critical role that banks have and with the aim of reducing the role of governments in saving them using taxpayers’ money should they run into trouble.

One aspect of this was regulators forcing banks to hold more capital to support lending, and being able to draw on this in times of difficulty – for example when loans can’t be repaid or when accessing liquidity becomes tricky.

This total level of capital that banks are now required to hold is made up of lots of different assets, including Additional Tier 1 bonds, or AT1s. They are part of a broader family of assets known as contingent convertible bonds, or CoCos.

The size of the AT1 market is around $260 billion, according to the Financial Times and that’s sprung up since they were introduced in the aftermath of the 2008 financial crisis. Deemed to be one of the riskiest ways to invest in banks, they offer high potential returns, or yields, but are also first in line for losses should the bank run into trouble.

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How is the World Economic Forum contributing to a more efficient, resilient, inclusive and equitable financial system?

The World Economic Forum’s Platform for Shaping the Future of Financial and Monetary Systems engages stakeholders across five industries: Banking & Capital Markets, Insurance & Asset Management, Private & Institutional Investors and Real Estate. The Platform is working with partners from the government and business sectors to design a more resilient, efficient and trusted financial system that reinforces long-term value creation and sustainable economic growth.

• Financial and Monetary Systems Financing the Transition to a Net Zero Future – An initiative to mobilize capital in support of critical decarbonization technologies required to transition the global economy to NetZero emissions.
• Green Building Principles – Principles that provide a roadmap to deliver net-zero carbon buildings, helping to accelerate action from a broad range of industries with significant real-estate footprints.
• Technology, Innovation and Systemic Risk – A project that seeks to explore the role of technology in both increasing and mitigating systemic risk in the financial system and, by extension, the broader economy.
• Building Resilient Economies and Societies – An effort by the financial sector in response to the COVID-19 crisis to design pathways towards greater societal resilience to future catastrophic shocks.

Contact us for more information on how to get involved.

So far, so technical.

But these instruments hit the headlines in recent weeks, particularly when Credit Suisse Group ran into a crisis of confidence and people moved to withdraw their money. The situation was compounded by banking jitters around the world.

The authorities stepped in and UBS Group took over Credit Suisse, with the Swiss regulator, the Financial Market Supervisory Authority (Finma), saying there would be a “complete write-down” of all of the bank’s AT1 bonds.

The decision to write down the AT1 bonds but pay some money to shareholders angered some investors, who said debt should always rank higher than equity when it comes to taking losses. Several questioned whether the move would have wider implications, with The Economist saying it could “even spell the end for the asset class” as wary investors avoid AT1s completely.

What is true is that this write-down represents the AT1 market’s biggest loss to date and could prompt a wider rethinking of banking rules and regulation.

“Governments, businesses and households will all have to grapple with persistent headwinds throughout 2023,” the Forum’s Chief Economists’ report says. “Financial conditions remain tight, with little scope for significant loosening, despite much of the world economy being at risk of recession.

So it seems the world of banking might be in the headlines for some time to come.