UBS's share price rose in response to its consideration of merging with a foreign bank to escape Swiss regulation.

The Swiss parliament's push for stricter capital requirements has further escalated the standoff between UBS and its domestic regulators.

On September 24, Semafor, citing sources familiar with the matter, reported that UBS executives have restarted discussions on how to remove the bank from the control of Swiss regulators, with a merger being one of the options.

Following the report's release, UBS shares rose as much as 1.9% in the US market. Morgan Stanley shares initially fell sharply before recovering somewhat, fueling speculation about potential merger targets.

The immediate trigger for this discussion was the Swiss parliament's passage of legislation this week requiring UBS to replenish up to approximately $20 billion in capital. UBS management stated that this requirement would severely weaken its profitable lending capabilities. CEO Sergio Ermotti expressed his dissatisfaction in strong terms.

One dark circle under the eyes is acceptable, but two dark circles plus a broken nose bridge is too much.

Parliamentary vote: UBS suffers major setback

The Swiss Federal Council's vote this week marks a significant setback for UBS in its year-long battle with its domestic regulators.

The 90% CET1 coverage requirement approved this time is far higher than the alternative supported by UBS, which only requires 50% coverage by CET1, with the remainder replaceable by Additional Tier 1 (AT1) capital.

The Swiss government had previously proposed a stricter 100% CET1 requirement, but it was rejected by the senators by a very narrow margin of 23 votes to 22. The final 90% proposal was therefore close to the government's position and far from UBS's expectations.

A broader amendment to the banking law passed the Federal Council by a vote of 33 to 10, but the legislative process is not yet over. The bill still needs to be submitted to the Swiss National Council for consideration, which has the power to amend or soften the provisions of the Senate.

With the legislative process progressing to the National Council, UBS still has a chance to secure a more moderate final solution. UBS is expected to continue lobbying, pushing for a 50/50 hybrid CET1 and AT1 model, while the Swiss government maintains its firm stance of 100% CET1.

Capital pressure: The cost of competition behind the numbers

The core of this regulatory controversy lies in the scale of potential capital pressure borne by UBS.

UBS estimates that 90% CET1 coverage will require an additional $16 billion in top-tier capital. Adding to this the approximately $2 billion from other regulatory measures this year, and the approximately $15 billion already required under current regulations following the acquisition of Credit Suisse, UBS's total incremental CET1 capital requirement at its Swiss parent bank level could reach approximately $33 billion compared to before the Credit Suisse acquisition.

UBS also estimates that the combined annual cost of the capital changes following the acquisition could reach approximately $2.5 billion.

For investors, the capital required to be retained by the parent bank means less funds available for share buybacks, dividends, and business expansion, thus putting downward pressure on long-term shareholder returns. If this cannot be compensated for by increasing profit margins, reducing costs, or shifting to businesses with lower capital requirements, the increased capital requirements will directly depress the return on equity.

UBS emphasized that the regulatory environment is significantly disadvantageous compared to its US counterparts. The Trump administration is pursuing deregulation policies, and capital constraints on US banking institutions are gradually being loosened.

Regulatory Logic: Lessons from the Credit Suisse Crisis

Swiss regulators are pushing for strict capital requirements because of systemic vulnerabilities revealed by the Credit Suisse collapse in 2023.

The regulators concluded that when a global bank falls into crisis, the capital held in its overseas subsidiaries is often difficult for the Swiss parent bank to access quickly. Requiring a higher proportion of the value of overseas subsidiaries to be covered by high-quality equity capital at the parent bank level aims to build a thicker buffer against potential losses, thereby reducing the risk that taxpayers will be forced to support troubled institutions again.

CET1 was favored by regulators because it mainly consists of common equity and retained earnings, allowing it to absorb losses immediately. While AT1 bonds also have loss-absorbing capabilities, their status was quite controversial during Credit Suisse's bailout.

At that time, AT1's debt of approximately 16 billion Swiss francs was written down in its entirety, while shareholders still received partial value compensation, which sparked strong doubts in the market.

UBS maintains that the well-designed AT1 remains an effective loss-absorbing tool, and that over-reliance on the more expensive CET1 will weaken its international competitiveness.

Merger Rumors: Multiple Paths to Relocate Out of Switzerland

Faced with escalating regulatory pressure, according to Semafor, UBS executives have restarted discussions about relocating the company's registration out of Switzerland, with a merger being the most popular option.

However, with a balance sheet size of $1.7 trillion and a market capitalization of $146 billion, UBS has a very limited pool of potential merger targets.

Semafor analysis indicates that Morgan Stanley has been a long-discussed potential candidate . The firm has previously expressed interest in acquiring UBS's $7 trillion wealth management accounts.

In addition, Standard Chartered Bank and Deutsche Bank are also considered relatively low-cost alternatives. It is worth noting that UBS Executive Chairman Colm Kelleher previously worked at Morgan Stanley.

UBS remains highly profitable and has ample capital, but this regulatory battle is increasingly pointing to a core issue: how much return will Swiss authorities allow shareholders to receive from UBS’s future profits?

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