Investors of $17.3 billion worth of Credit Suisse's AT1 bonds, or "Additional Tier-1" bonds, found that they will get absolutely nothing in a state-backed UBS emergency takeover deal of the lender on Sunday.

The resulting case of shareholders being better protected than bondholders stunned global markets. When a bank fails, the usual hierarchy is that bondholders rank above shareholders and bondholders would typically get their money back first.

However, in the case of Credit Suisse, its bonds' terms stated that the Swiss financial watchdog is not obligated to follow the traditional capital structure in a restructuring.

And that was exactly what the Swiss regulator, FINMA, did: completely writing down AT1 bonds to increase Credit Suisse's liquidity while shareholders received $3.23 billion.

What are AT1 bonds?

AT1 bonds belong to a $275 billion family of "contingent convertibles" bonds, or "CoCo" bonds. These bonds, created in the wake of the 2008 financial crisis, were designed to prevent the need for using taxpayer money to bail out troubled banks. Instead, financial institutions themselves "bail-in" by establishing this emergency capital mechanism to absorb losses.

When a bank's capital falls below certain levels relative to assets, it would automatically trigger AT1 bonds to convert to equity to boost liquidity or written off. Facing the risk of a write-down, AT1 bonds typically offer a higher yield, making them popular among institutional investors.

What happens now to AT1-bond investors?

Some Credit Suisse AT1 bondholders are questioning the legal basis for the losses resulting from the state-backed rescue. Law firm Quinn Emanuel Urquhart & Sullivan said Monday that its lawyers are talking to the AT1 bondholders about options for legal action.

The potential risks of holding AT1 bonds have spilled over to the bond market in Europe. Investors are fearing a wipeout of their holdings in case of another bank collapses as the Swiss regulators have set a precedent. AT1 bonds issued by other European banks fell sharply on Monday.

Analysts have said investors will now be much more cautious about making new purchases of AT1 bonds.

In an attempt to calm investor nerves, European regulators said in a Monday statement that AT1 bondholders would only experience losses after shareholders, adding that Credit Suisse is an isolated case. AT1 bonds issued by European lenders rose following regulators' assurance.

Read more: Credit Suisse buyout isn't a 'done deal' yet

(With input from Reuters)