**Watershed moments** AT1 bonds, introduced as replacements for former Tier 1 securities, were designed to absorb loss-es on a going-concern basis. However, following Credit Suisse's (CS) apparent failure to respect the debt hierarchy—a well-documented event that continues to fuel debate and legal action, see Alliance-Bernstein as the latest example—investors have begun questioning whether these instruments remain fit for purpose. Before the CS incident, the previous precedent was Banco Popular in Spain in June 2017, where AT1 and Tier 2 holders incurred 100% losses, and the bank was sold for €1 to Santander after being declared bankrupt by the Resolution Authority. (Single Resolution Board – SRB). In the aftermath of the CS episode, the Bank of England, SRB, EBA, OSFI, and ECB issued clarifications regarding AT1 bonds. These actions were critical to restoring investor confidence in this asset class. (I have previously shared my perspective on FINMA's decision to write off AT1 bonds, so I will not reiterate it here.). After many months, it is now evident that the AT1 framework requires changes. To demonstrate that something needed to be modified with Swiss banks, when UBS issued its AT1 in November 2023 (its first securities in CoCos format after the acquisition of CS), the proposed notes included a clause—eventually approved in April 2024—introducing an equity conversion mechanism in the event of a trigger breach or a viability event. This change reassured investors by providing the possibility of retaining some value through conversion into share capital of the bank rather than suffering a complete write-down in CS style. **A shock absorber that needs to work** The concepts of Point of Non-Viability (PONV) and Failing or Likely to Fail (FOLTF) remain ambiguous and subject to discretionary interpretation by the relevant authorities. Investors have learned that the loss absorption trigger is unlikely to provide timely or meaningful support to a bank during periods of stress, casting doubt on the suitability of AT1s for their intended role. Historically, loss absorption on a going-concern basis has been rare for precisely this reason. A more robust framework is necessary, as the ECB acknowledged before the CS crisis: “_The challenges associated with market perceptions of the features of AT1 instruments point to a more fundamental concern over the complexity of the capital framework._” (ECB response to the European Commission’s call for advice on the review of the EU macroprudential framework, March 2022) If investors cannot fully comprehend and quantify the risks they are exposed to, it becomes impossible to assign fair value to these hybrid instruments. Investors must conduct thorough due diligence before committing to any asset class. A clear understanding of the associated risks is essential to justify investments in higher-yielding products. AT1s have more than one risk. However, informed decision-making regarding AT1s—whose primary goal is to "safeguard value" by absorbing losses of a solvent bank under stress—is hampered by two opposing forces. On one side are banks, which prefer to continue issuing mispriced equity/debt instruments with the current set of rules to minimize funding costs. On the other side are regulators, who are still weighing the benefits and constraints of the current AT1 framework, as well as the uncertain implications for broader bank equity requirements (higher than today) in a revised regulatory landscape (likely leading to lower banks profitability). Meetings between the Basel Committee on Banking Supervision and bank executives, investors, and credit rating agencies, such as those held at the beginning of 2024 to gather participants' views on AT1s, concluded without addressing the most critical issues. For years, market expectations regarding AT1 loss absorption on a going-concern basis have diverged from regulatory expectations. It is not merely a case of being lost in translation; it is likely a pact of mutual acceptance and forbearance. Until "_workable AT1s_" (as defined by the European Banking Institute, referring to instruments capable of fulfilling the prudential function of going-concern loss absorption) are introduced, investing in CoCos will remain unpredictable and risky. This is unfortunate for a market valued in Europe at approximately €220 billion, encompassing more than 300 ISINs and nearly 100 participating banks. My point for investors: the issue isn’t understanding instrument’s volatility; it’s about identifying its value when everyone else is chasing momentum. My point on regulation: what measures or framework truly ensure the systemic stability of the banking system? “CoCos can drive markets Cuckoo”. (title of the article written by Hilary J. Allen, 2011): a visionary piece.

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AT1s: Perhaps a second thought?