Credit Suisse's rescue had a sting in its tail for the banking crisis. Here's what you need to know about AT1 bonds.

• Credit Suisse was rescued by its longtime rival UBS on Sunday.
• As part of the deal, the Swiss regulator wrote down the value of the bank's so-called AT1 bonds to zero.

UBS bailed out its longtime rival Credit Suisse in a historic $3 billion deal Sunday – but there was a sting in the tail for holders of the beleaguered Swiss bank's so-called Additional Tier 1 bonds.

The Swiss markets regulator FINMA marked the value of Credit Suisse's AT1 debt securities down to zero when the takeover was announced, sparking outrage amongst investors and dragging down other European bank stocks.

Here's what you need to know.

What are AT1 bonds?

AT1 bonds, which are also known as contingent convertible bonds or CoCos, emerged as a new type of fixed income asset after the 2008 financial crisis.

They're a riskier type of bond that offers a higher yield than assets that are typically considered safer, like government debt.

For example, while yields on 10-year US Treasury notes currently sit at around 3.58%, Credit Suisse's CoCos had a coupon rate of 9.75%.

AT1s are also hybrid bonds – which means that the bank can choose to convert them into shares if its financial health falls below a certain level. This serves to prop up the bank's capital levels and reduce its debt in times of crisis.

What happened at Credit Suisse?

FINMA said Sunday that it would write the value of Credit Suisse's AT1s down to zero, effectively wiping out assets worth 16 trillion Swiss franc ($17 billion) overnight.

Bondholders typically rank higher than shareholders when it comes to repayment of capital – but owners of Credit Suisse CoCos have been left with nothing after the FINMA move, while shareholders have the option to sell their shares to UBS for around 0.70 Swiss francs ($0.76) as part of the takeover deal.

The litigation firm Quinn Emanuel said Monday that it had put together a team of lawyers and was approaching AT1 holders about potentially pursuing legal action over FINMA's move.

But it could be a case of misreading the fine print – because Credit Suisse's CoCos were specially structured in a way that allowed the regulator to write them down to zero at investors' expense.

Has this happened before?

Yes – but very few times, and never before involving a bank the size of Credit Suisse.

The closest parallel to Sunday's move by FINMA came when Spain's Banco Popular collapsed in 2017, although shareholders and AT1 bondholders were both wiped out as part of its rescue by rival Banco Santander.

A group of CoCo bondholders then instructed Quinn Emanuel to pursue legal action on their behalf, although they failed in their attempt to sue the regulator.

Why does it matter?

FINMA's write-off of the Credit Suisse bonds sent European banks' AT1 bonds tumbling with investors pricing in the risk of their holdings being written off by regulators.

Invesco's AT1 Capital Bond ETF, a fund that tracks the sector, plunged 14% when markets opened Monday, although it pared back some of those losses and finished the trading session just under 5% lower. Shares in big bank stocks like BNP Paribas, Santander, and even UBS itself also plummeted Monday.

It could become harder for banks to raise debt if investors shy away from buying CoCo bonds, which were a $260 billion market last year, according to data from the Financial Times. That raises the risk that FINMA's move prolongs the banking crisis that's gripping the continent after UBS's rescue of Credit Suisse.

"That appears to have spooked investors and has led to a sell-off in other bank debt and that's weighed on share prices," AJ Bell investment director Russ Mould said.

"It means the banking crisis we've seen over the past few weeks has started a new chapter rather than reaching its ending," he added.

Read more: Credit Suisse rescue: The biggest winners and losers from UBS's historic deal