In this week's blog, the apparent topical story to cover is the demise and takeover of Credit Suisse by their peer competitor UBS. But, as many are covering the finer details of how events unfolded, we are focusing on risk perception. Risk, the way it's packaged, accepted, considered and ultimately sold to the public, is highly pertinent in the world of P2P; all websites in our sector carry enhanced warnings about the decisions you are about to make, making you, the investor, aware of the potential outcomes. Deep inside the Credit Suisse bond literature, there are some clauses about 'write down scenarios' that weren't visible in a glowing neon box across the top of the Credit Suisse website, but in the fine microprint of the literature, only now to be unearthed in what may become an international court battle that redefines peoples perspective on risk, and the way financial institutions package and sell it.
Firstly it's necessary to understand briefly what a Contingent Convertible bond, or a "coco bond", is, given it's a $250 billion market now called into question and the protagonist in this story. Coco bonds were invented after the 2008-2009 financial crisis to allow banks to increase their capital requirements without selling shares. It can be classified as a medium-to-high-risk debt instrument (unsecured bond) that enables the issuer to raise capital, and the investor gets a coupon in return. The rate of return is bond esq in size, and it's perpetual, so there is no redemption date. So, if there is no redemption date, it's illiquid & tied to the fortunes of the business that issues it; why not look at shares? Well, there are two major selling points with the bond; firstly, it's fixed income, so in a time of volatility and uncertainty, it's immediately attractive to investors looking for continuity. The second point is the contentious issue here; should a disaster occur, the hierarchy of losses typically positions these bondholders above the shareholders in the pecking order. So although you are running the risk of a total write-down should the bank fail, your demise wouldn't be guaranteed in the way the shareholders of the failed business would be.
In the instance of Credit Suisse, this hasn't happened; UBS brokered a deal with the Swiss national bank to acquire Credit Suisse for $3 billion Swiss francs, or 60% of the bank's final closing price, with a caveat in there to write down $17 billion worth of AT-1 bonds, compensate the shareholders, and even honour some staff bonuses. So the argument here isn't that the bondholders shouldn't be exposed to this level of risk; it is, after all, in the microprint of the T&Cs as a possibility, it's that standard equity instruments, i.e. stocks, should be the first ones to absorb losses, certainly in a takeover situation where equity is still available. The bonds could still be theoretically converted.
So what do these events say about risk? There will be countless arguments about how the bank's counterparties sold these products; the surprise of many wealth managers in the press regarding the decisions undertaken by the Swiss authorities indicates that a product crowned with a AAA or AA+ rating shouldn't have so quickly fallen apart. Still, one interesting question to pose is, does an AT-1 Bond's success have any correlation with the success of the business that issued it? Suppose the answer, as one imagines is obviously yes. In that case, Credit Suisses' share price has been in abject decline since 2018, so how can that still be rated AAA unless there is some underlying assumption of a bailout should the heavens collapse? That is the crux of the debate; in the case of assumption vs small print, the court rests.
Bringing this back to P2P and the way our industry is categorized for risk, we continually present a strong argument that so much of risk is subjective and based on perception, the narrative that investors may not understand what they are embarking on with P2P is in our eyes a tenuous argument at best, it's unsupported, and it's something we will actively rally against with our own counter-narrative. If that's through comparisons with a world deemed more sophisticated, pointing out hypocrisies in the broader industry, or just asking interesting questions, these written pieces are meant to provoke thought about our industry and push back against the stereotypes it carries.
Events that change people's perceptions of risk, bank runs, brands failing, and "things that you know, just not being so", to paraphrase a miss attributed Twain quote, are vexing; they tip people's understanding upside down and make people question things, it's as confusing as this meandering paragraph! However, one of the potential positives is that ....they make people question things - disruptors and agitators; businesses offering a new way of doing things don't pose the real risks after all; perhaps lack of change is the real risk here.
The concept of P2P is relatively simple, and in its simplicity, we believe that the risks and rewards are transparent, allowing our investors to understand the mechanics involved, which is ultimately the best way to enable individual investors to make the right choices for them, and that's why we stand behind the transparency and success of our asset class.
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