Archegos fine points to a much bigger issue for UBS

UBS has added another $4 billion in provisions as part of its takeover

Paul J. Davies

UBS AG’s takeover of Credit Suisse Group AG might have been a sweet deal, but the rescuer still must pay to clean up its failed rival’s messes — and there are many.

Among the biggest relates to Archegos, the family office-turned-hedge fund, which collapsed in early 2021 and hit Credit Suisse with losses of more than $5 billion, the worst among all the brokers that dealt with the fund. The bank was always going to be penalized by regulators for its ineptitudes in that debacle — and UBS as the new owner must pick up the tab.

An early estimate that the fines will total nearly $430 million, according to a report by the Financial Times, should probably leave executives and investors somewhat relieved. It could have been much worse. However, it is a reminder of a bigger and potentially more important issue for UBS— namely the capital demands it faces from Swiss regulators to cover Credit Suisse’s past failings, misconduct and other operational risks.

On the Archegos fine itself, one yardstick for comparison is the $920 million in penalties paid by JPMorgan Chase & Co. to US and UK regulators in 2013 after its London Whale credit derivatives trading failures, according to Bloomberg Intelligence. That was when part of the bank’s in-house treasury team took outsized positions in the markets, then lost $6.2 billion as other investors moved against them.

Credit Suisse lost less money than that on Archegos, so its penalties are likely to be lower than JPMorgan’s. But they could have been much higher than the initial estimates of $300 million from the Federal Reserve and £100 million ($128 million) from the UK’s Prudential Regulation Authority. And these totals might still be reduced during settlement talks.

UBS has more than enough money put aside to cover exactly these kinds of costs. Credit Suisse already had about $1.3 billion in provisions for litigation, though only about $35 million of that was for the Archegos case. UBS has added another $4 billion in provisions as part of its takeover. (When doing a deal, banks are allowed to put aside much larger amounts than under normal accounting rules.)

Yet the bigger, more complex question for UBS is about the extra capital demands. Regulators apply charges to banks for operational risk, which covers a range of exposures such as IT systems failing, losses from rogue traders, as well as litigation. The more a bank pays out in fines or court settlements, the greater the operational risk charges.

These charges are added by increasing the total risk-weighted assets on a bank’s balance sheet, the measure of size used to calculate its capital needs. Operational risk assets don’t generate any income, they just increase capital demands, so higher charges cut the returns that banks generate from their financial assets. This matters for investors.

Credit Suisse already carried more operational risk than UBS. At Credit Suisse, operational risk-weighted assets accounted for 30% of its total risk weighted-assets at the end of the first quarter, versus 25% at UBS.

Operational-risk charges that arise from past misconduct or lawsuits can hang around for years even if a bank has stopped doing the business that got them into trouble. So, for UBS, closing down large parts of Credit Suisse’s investment-banking and markets business, as it is expected to do, might not deliver a cut in operational-risk capital linked to those activities.

Then there is the pile of litigation and regulatory actions that Credit Suisse still faced when it collapsed, including its appeal against a conviction for facilitating money laundering for a Bulgarian cocaine smuggler and ongoing lawsuits related to its role in the Mozambique tuna bonds scandal. UBS will have to deal with all these and potentially meet capital charges for them, too.

Just how much operational risk Credit Suisse adds to UBS will be a key debate between the bank and its regulators in the months ahead. The long and difficult integration it must do adds to the potential pitfalls it faces, which could also entail further capital demands. The answers UBS gets from regulators could make a big difference to the returns it can generate from this deal for investors.

Paul J. Davies is a Bloomberg Opinion columnist covering banking and finance.