Switzerland: UBS Restructuring, 2008

Following the collapse of Bear Stearns in March 2008, the SNB, in cooperation with the SFBC and the Swiss federal government, prepared a plan to purchase illiquid assets from UBS (SNB 2009). A month after Lehman Brothers collapsed in mid-September, there was a severe deterioration in market conditions, and capital markets dried up due to increasing uncertainty. To restore confidence and provide stability, the Federal Council, SNB, and SFBC announced a series of measures to strengthen the Swiss financial system (Swiss Federal Council 2008c). Some of these measures aimed specifically at rescuing UBS, which was in a critical state due to an outsized exposure to bad assets that suffered large losses, declining confidence, and a high risk of insolvency (SNB 2013b).

A central element of the UBS rescue package consisted of a plan to create an SNB-controlled SPV, StabFund, and allow UBS to transfer up to USD 60 billion in bad assets to StabFund. This measure provided UBS with liquidity while relieving its balance sheet of risky assets. The SNB could bear these risky assets since it had a longer-term horizon and could wait for the markets to recover before liquidating them (Swiss Federal Council 2008b). At the news conference announcing the rescue measures, SNB Chairman Roth said that the rescue operation was highly unusual in its scope and reasons. Chairman Roth also said that a properly functioning banking system was essential to the Swiss economy, and it was better to carry out the rescue measures sooner rather than later under potentially more adverse conditions (Roth 2008).

Overall, StabFund acquired approximately USD 24.8 billion in securities and USD 5.4 billion in loans (SNB 2010b). UBS also transferred USD 8.8 billion in contingent liabilities to StabFund, which did not require any immediate financing (SNB 2013b). UBS’s book value for these assets on September 30, 2008, and the valuation determined by independent experts established two prices for the assets transferred, and StabFund paid the lower of these two values in each transaction. The independent valuation experts used several methods to consider as many price-related aspects as possible (SNB 2009).

The decision to purchase illiquid assets from UBS was made solely by the Governing Board of the SNB since the Governing Board alone is responsible for the conduct of “monetary policy” (Swiss Government 2003, arts. 6, 46).

The Swiss Federal Council announced that the Swiss federal government (Swiss Confederation) would subscribe to CHF 6 billion of MCNs issued by UBS on the same day that the SNB announced the StabFund plan. This measure was intended to recapitalize UBS and ensure that its capital base was not impaired by the financing of StabFund (Swiss Federal Council 2008c; UBS 2008). The SNB stipulated the recapitalization of UBS as a condition for the StabFund transaction (SNB 2008d; SNB 2009). The Federal Assembly of the Swiss Confederation authorized the capital injection on December 15, 2008 (Swiss Government 2008).

Approximately eight months later, on August 19, 2009, the Swiss Confederation announced its intention to exercise the right to convert the MCNs to equity and sell the shares received through conversion to institutional investors. The Confederation agreed to waive the right to receive coupon payments on the MCNs in exchange for approximately CHF 1.8 billion (UBS 2009a). The Confederation placed the newly issued shares with private institutional investors for approximately CHF 5.5 billion (Hänni 2010). The Confederation, therefore, received approximately CHF 7.2 billion when it sold its entire stake in UBS and the right to receive coupon payments on the MCNs, after accounting for transaction fees (Martinuzzi and Wille 2009; UBS 2009a). See Makhija (2023) for further details regarding the capital injection.

On December 20, 2008, the Swiss government enacted the Depositor Protection Reinforcement Act to strengthen the Swiss deposit guarantee system and revise the maximum amount of deposits guaranteed to CHF 100,000 per customer (esisuisse n.d.).

A legal opinion by the SNB evaluated whether the transaction was covered under the SNB’s statutory mandate and business scope to establish that the rescue measure had a legal basis in central bank law (SNB 2009). We summarize the expert opinion analysis in this section.

Statutory Mandate

Article 5 Paragraphs 2(a) and (e) of the National Bank Act (NBA) give the SNB the responsibility of providing the Swiss franc money market with liquidity and contributing to the stability of the financial system (Swiss Government 2003). The legal opinion concludes that the SNB derives its role as the lender of last resort (LOLR) from Article 5 Paragraphs 2(a) and (e), and this role has been repeatedly emphasized by the Federal Council.

The SNB’s Governing Board set guidelines for the conditions under which the SNB can grant emergency liquidity assistance (ELA) in its function as the LOLR (SNB 2023). The conditions to grant ELA are as follows:

­­­­­– The bank or group of banks seeking credit must be of importance for the stability of the financial system.

–  The bank seeking credit must be solvent.

–  The liquidity assistance must be fully covered by sufficient collateral at all times. The SNB determines what collateral is sufficient (SNB 2023).

The guidelines define banks as systemically important if their insolvency would seriously impair the functioning of the domestic financial system or significant parts of it and adversely affect the real economy. In 2008, UBS accounted for one-third of the transactions on the Swiss interbank credit market, and its failure was expected to destabilize the entire Swiss payment system, create significant losses for other banks, and affect households and businesses. International studies also estimate that the default of a bank as large as UBS would carry an economic cost of 15%–30% of GDP in the short term and 60%–300% of GDP in the long term (Swiss Federal Council 2008c).

Since it is difficult to distinguish between solvency and liquidity problems during a crisis, the SNB based its assessment of UBS’s solvency on a statement from the SFBC indicating that UBS was solvent under applicable supervisory rules (SNB 2009, 77). Establishing UBS’s solvency was a prerequisite to the transaction since the SNB can grant only liquidity assistance, not solvency aid. The legal opinion also highlighted that the loan to StabFund did not represent liquidity assistance in the traditional sense since the SNB indirectly assumed the risk on the assets transferred to StabFund. However, the transaction allowed UBS to exchange illiquid assets for liquid assets, thus having a substantial liquidity effect (SNB 2008d).

The third condition for ELA regarding sufficient collateral was also met since Article 9 of the NBA grants the SNB extensive discretion in deciding what collateral is sufficient within the context of ELA. The Governing Board of the SNB could exercise this discretionary power (SNB 2009).

Business Scope

Article 9 Paragraph 1(e) outlines that it is within the SNB’s business scope to enter into credit transactions with banks and other financial market participants on condition that sufficient collateral is provided for the loans (Swiss Government 2003). StabFund was actively engaged in financial markets since it managed and liquidated the portfolio of assets transferred from UBS, and thus could be classified as a financial market participant. The SNB’s agreement with UBS regarding the transfer of illiquid assets to StabFund also provided the SNB with loss protection mechanisms, such as warrants and regulation of payment flows, that could be classified as sufficient security (SNB 2008d).

The SNB’s purchase of illiquid assets from UBS’s balance sheet also had a legal basis through Article 9 Paragraph 1(c) of the NBA, which states that the SNB can “buy and sell, in the financial markets, Swiss franc or foreign currency denominated receivables and securities . . .  or enter into lending operations therewith” (SNB 2008d, 9–10; Swiss Government 2003, art. 9).

The Governing Board of the SNB decided to provide aid to UBS by purchasing its illiquid assets since the Governing Board is solely responsible for “monetary policy” (Swiss Government 2003, arts. 6, 46; SNB 2009, 81). The SFBC licensed StabFund, and the SNB established and managed it.

StabFund had an operational management team staffed by the SNB and led by a general manager. The general manager was appointed by StabFund’s board of directors and was supported by six specialists. The operational management team was based in Zurich and responsible for risk control, portfolio management and market intelligence, legal and compliance, and corporate secretariat duties. The SNB was responsible for the financial and fund accounting, taxation, and other infrastructure services and was compensated by StabFund (SNB 2010b).

StabFund outsourced the asset management to a 75-member team from UBS based in New York and London and several UBS personnel that provided operational support. UBS had several incentives to fulfill its asset management function appropriately since it could participate in the profits of StabFund after the fund repaid the SNB loan and would not be compensated for its asset management services unless the SNB loan was repaid. The SNB could also replace UBS as the asset manager (Szelyes and Zimmermann 2010). Martin Hellwig also notes in his paper to the European Parliament that this incentive structure was a reason for StabFund’s success (Hellwig 2017).

StabFund appointed Northern Trust as its custodian and for some accounting and reporting functions (SNB 2010b). StabFund also appointed PricewaterhouseCoopers Ltd (PwC) as its auditor (SNB 2009).

StabFund contracted several independent valuation experts in the US, Europe, and Japan, and received support from external advisors on legal, organizational, and asset management issues.

StabFund’s board of directors consisted of three representatives from the SNB and two from UBS and was responsible for overall management, supervision, and control of the fund (see Figure 2). The board of directors established liquidation guidelines on July 23, 2009, for the assets transferred and reviewed them every quarter. The investment guidelines adopted by the board of directors set reporting requirements for UBS and required UBS to disclose any conflicts of interest in its function as a bank and investment manager. The board of directors also set limits for sales volumes and potential losses from sales for the investment and general manager (SNB 2010b). The Swiss National Bank Council’s Risk Committee^FThe SNB Council oversees and controls the conduct of business by the Swiss National Bank while the Governing Board is the executive body responsible for monetary policy, asset investment strategy, and international monetary cooperation (SNB n.d., 1). supervised the effectiveness and adequacy of the investment and risk control process. The SNB Council’s Audit Committee monitored compliance with International Financial Reporting Standards (IFRS) accounting and operational risk rules (SNB 2009).

On October 16, 2008, the Federal Council, SNB, and SFBC issued a press release outlining the rescue measures provided to UBS. Through this press release, the Swiss authorities communicated that the measures were taken to stabilize the Swiss financial system and restore market confidence (Swiss Federal Council 2008a). Chairman Roth also spoke at a news conference on October 16, 2008, and stated that the measures were implemented to restore confidence and stability in the Swiss banking sector (Roth 2008). Later, in a speech at a general meeting of shareholders of the SNB, he said that the rescue decision was based solely on stabilizing the financial system and economy, and not on financial considerations (Roth 2009). The SNB restated that the rescue measures should not be judged on their financial success, and their primary objective was stabilizing the financial system when UBS purchased StabFund.

The SNB also communicated changes to details of the program, such as StabFund’s domicile and reduction in the amount of assets transferred, through various press releases and in its annual reports between 2008 and 2013

When the government intervention in UBS ended, Thomas Jordan, a member of the Governing Board of the Swiss National Bank and former president of StabFund’s board of directors, reiterated that although the program was financially successful for the Swiss government, its primary objective was to stabilize UBS and the Swiss financial system (SNB 2013b).

The former president of the Swiss Confederation decided that no Federal Council meeting minutes would be taken regarding the UBS case to preserve confidentiality (Control Committees 2010).

The SNB committed to fund StabFund up to USD 60 billion with a combination of loans and capital upon each asset transfer. It covered 90% of the costs of each asset transfer with a loan and 10% in the form of StabFund equity. Upon each asset transfer, UBS financed the SNB’s purchase of StabFund equity by buying from the SNB a call option to purchase the fund’s equity (UBS 2009c). The price of the call option was set at an amount equal to the SNB’s equity contribution to the fund on that date, and UBS had the right to exercise the call option upon repayment of the SNB’s loan (SNB 2009). Through that mechanism, the SNB carried the risk of loss on its loan to the fund but not on its equity in the fund (UBS 2009b).

The SNB required UBS to raise capital to cover the cost of the call option. Owing to the urgency of the capital injection following the announcement of the rescue package and the lack of private sector interest, private sector capitalization did not seem possible, and the Confederation agreed to recapitalize UBS (Bäumle 2008). The Federal Council announced that the government would subscribe to CHF 6 billion of MCNs issued by UBS to help the bank retain a strong Tier 1 capital ratio after providing the funding to SNB to capitalize StabFund via the call option (Swiss Federal Council 2008c).

This funding mechanism was slightly different compared to the original funding structure announced on October 16, 2008 (SNB 2008a). The change in funding strategy allowed UBS to report it purchased a derivative for CHF 4.8 billion and the derivative’s fair value was CHF 1.2 billion, for a loss of CHF 3.6 billion, instead of reporting UBS purchased equity capital in StabFund for CHF 4.8 billion and incurred a CHF 4.8 billion loss on the capital by selling the equity to the SNB for CHF 1 (UBS 2009c).

Between December 2008 and April 2009, UBS transferred a total of USD 38.7 billion in assets and contingent liabilities in three tranches (SNB 2010b). This transfer of assets to StabFund was financed by a combination of loans and capital from the SNB, as noted. The remaining USD 8.8 billion in contingent liabilities did not require financing immediately. The SNB’s loan was nonrecourse to UBS, and the SNB charged an interest rate equal to the one-month USD London Interbank Offered Rate (LIBOR) plus 250 basis points (bps) (SNB 2008a; UBS 2009b). The SNB’s loan to StabFund was secured by StabFund’s assets, the equity contribution, and through a warrant the SNB received for 100 million shares of UBS (representing 3.41% of total UBS equity at the time), which could be exercised if the SNB incurred a loss on the loan and served as a second loss protection. The exercise price of the warrants was CHF 0.1 per share, the par value of the shares. The SNB’s loan to StabFund was for a term of eight years, but it could be extended to a maximum of 12 years to allow for an orderly liquidation of assets (SNB 2008a).

The SNB had to verify that sufficient eligible collateral was provided for this transaction, and the National Bank Act grants broad discretionary power to the Governing Board of the SNB to decide which collateral it considers sufficient within the context of an emergency liquidity supply facility (SNB 2009).

In November 2013, after StabFund fully repaid the SNB loan, UBS exercised its call option to purchase StabFund’s equity, paying USD 3.8 billion. The SNB also gained interest income of USD 1.6 billion over the term of the loan. The total compensation generated from the management of StabFund was USD 5.2 billion for the SNB, which represented a yield of 8% per annum (p.a.) on the average loan or a yield of 6.1% p.a. on average risk exposure (SNB 2013b).

On October 15, 2008, the SNB and UBS signed a term sheet laying out the details of the restructuring plan involving a sale of bad assets from UBS’s balance sheet to an SNB-owned SPV (SNB 2009) (see Figure 3). Under the terms of the agreement, if there was a change of control of UBS, the SNB had the right to require UBS to purchase the outstanding loan at par plus accrued interest and to purchase StabFund’s equity at 50% of its value at the time (UBS 2009b).

The agreement between the SNB and UBS originally planned for the SPV to be established as a limited partnership domiciled in the Cayman Islands. The SNB had used this structure in the past, so it could be implemented quickly. However, this structure for the SPV was met with some political criticism (Bäumle 2008). In cooperation with the Swiss federal government and the canton (state) of Berne, the SNB created a solution to establish the SPV as a limited partnership for collective investment under the Federal Act on Collective Investment Schemes and the Swiss Code of Obligations. This corporate structure satisfied the requirements regarding liability and ensured tax exemption (SNB 2009).

Ultimately, UBS injected the equity capital by paying a premium for an option to purchase StabFund after the SNB loan was fully repaid (SNB 2008b). UBS made the premium contributions in steps corresponding to the transfer of assets (SNB 2009).

Although the SNB and UBS agreement allowed for an asset transfer of up to USD 60 billion, the SNB and UBS agreed in January 2009 not to transfer a portion of the initially planned assets. Between October 2008 and January 2009, the SNB conducted an extensive analysis and concluded that due to changes in international accounting standards, certain assets could be classified as loans and receivables, which allowed UBS to not mark these assets to market. As a result, the SNB and UBS agreed to reduce the maximum permitted transfer amount to USD 39.1 billion from USD 60 billion (SNB 2009).

The assets transferred were financed by USD 3.9 billion (10% of asset transfer value) of capital provided by UBS, a loan of USD 25.8 billion provided by the SNB to StabFund, and the remainder of USD 8.8 billion consisted of contingent liabilities, which did not require any financing (SNB 2013b).

The SNB board members communicated that they were considering other restructuring plans. However, no details were released regarding these plans.

The agreement to purchase UBS’s illiquid assets gave the SNB a warrant for 100 million shares of UBS at a nominal value (representing 3.41% of total UBS equity at the time), which the SNB could exercise if it incurred a loss on the loan. The exercise price of the warrants was CHF 0.1 per share, the par value of the shares (SNB 2010a; UBS 2009b; 2013). If the loan was not fully repaid, the SNB could have exercised this warrant, which would have been dilutive to existing equity holders.

The transfer of assets did not affect any of UBS’s depositors; however, some borrowers had their loans transferred to StabFund.

Between December 2008 and April 2009, UBS transferred more than 5,000 portfolio positions worth USD 38.7 billion of securities, loans, and derivatives, in three tranches (see Figure 4). The price of the assets transferred was approximately USD 1 billion below the book value of assets at UBS at the end of September 2008 (Jordan 2009). StabFund contracted several independent valuation agents based in the US, Europe, and Japan to provide a valuation for the assets transferred as of September 30, 2008, which was the date the SNB indirectly assumed the asset risk through StabFund. StabFund purchased the positions at the lower value of the UBS book value as of September 30, 2008, and the average valuation assigned by the independent valuation agents (Szelyes and Zimmermann 2010).

The derivatives StabFund acquired were primarily credit default swaps in which the StabFund acted as protection seller or buyer. StabFund took over the risks of the protection seller from UBS, and the income it received from these derivatives included the premium for selling protection. The amount StabFund might have had to pay in the event a CDS was triggered was held ready in bank deposits and regularly recalculated based on continuous valuations of the contracts. On December 31, 2009, the potential liabilities from these derivatives amounted to approximately USD 7 billion, and the deposited collateral was approximately USD 7 billion as well. If StabFund did not have sufficient liquid funds to service any outstanding payments, it could apply for an additional loan drawdown from the SNB (SNB 2010b).

Then–CEO of UBS Peter Wuffli stepped down following the announcement of large losses in 2007 (Creswell 2007). In March 2008, the SFBC called for then–chairman of the board of UBS Marcel Ospel to resign; he resigned in April 2008 during the bank’s annual general meeting (Control Committees 2010). In addition, two other board members, Stephan Haeringer and Marco Suter, also resigned. These executives voluntarily waived or repaid part of their compensation, totaling CHF 45 million (Dealbook 2008).

More than 80% of the SNB loan to StabFund was US dollar-denominated; however, the SNB could not use its foreign exchange reserves to finance the loan since it would have severely depleted the reserves. The SNB also wanted to make its loan in the same currencies as the assets purchased to reduce currency risk (SNB 2009). The SNB initially fully refinanced the loan through a swap facility with the Federal Reserve Bank of New York. In February 2009, the SNB sought a more market-oriented refinancing option for the loan and issued SNB debt denominated in US dollars (Szelyes and Zimmermann 2010). After July 2010, the SNB refinanced the loan using foreign exchange reserves (Jordan 2009).

The SNB and Federal Council imposed restrictions on UBS’s compensation structure for bonuses and severance pay. The Swiss authorities also set directives for corporate governance at UBS and held regular meetings with the management; however, they did not place specific restrictions on pay structure or dividends (Swiss Government 2008; Voxant 2008). The SNB was also given the right to conduct additional risk management reviews at any time as long as the federal government held over a 3% stake in UBS related to the capital injection. These risk management reviews could include participation in internal meetings regarding risk management and control at all hierarchical levels, obtaining information through questionnaires and interviews with risk managers, and accessing internal data and documents related to risk management without providing prior notice (Swiss Federal Council 2008b).

StabFund fully repaid the SNB’s loan on August 15, 2013, and UBS exercised its option to repurchase the fund on November 7, 2013 (SNB 2013a). The SNB had projected that the loan would be fully repaid by October 2014, so the program concluded a year earlier than expected. When StabFund was wound up, it mainly consisted of cash equivalents, and no troubled assets were returned to UBS. The SNB did not bear any financial losses; in fact, it generated approximately USD 5.4 billion in profits and interest income (SNB 2013b).