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Contingent convertible bond

From Wikipedia, the free encyclopedia

A contingent convertible bond (CoCo), also known as an enhanced capital note (ECN)[1] is a fixed-income instrument that is convertible into equity if a pre-specified trigger event occurs.[2] The concept of CoCo has been particularly discussed in the context of crisis management in the banking industry.[3] It has been also emerging as an alternative way for keeping solvency in the insurance industry.[4]

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  • CoCo Bonds (Contingent Convertible bonds)
  • Convertible Bonds
  • How to Price Contingent Convertible Debt (CoCo's)


One good thing about a crisis is that a crisis changes things. That is especially true for the 2008 global financial crisis. Government and regulators had no choice but to bail out many institutions globally during that period with taxpayers’ money. They had to review the whole process and improve it. They invented and introduced many new measures hoping that in the future, when financial institutions are in distress, firms can be orderly wound down or the loss will be taken by stakeholders rather than taxpayers, so the whole financial system will remain intact. CoCo is one of these measures; an important one. CoCo is short for contingent convertible. They are the securities that will absorb losses in accordance with their contractual terms when the capital ratio of the issuing bank falls below a certain level; usually 5.125% which is lower trigger and 7% which is high trigger. Most CoCo bonds also have the statutory bail-in clause either in their terms and conditions or in the risk factors of the prospectus, which means relevant authorities have the power to impose losses on CoCo holders even if the trigger level has not been breached. How the authority determines the bail in can’t be predicted and there is no available formula. There are three different ways for CoCo Bond to absorb losses: convert to equity, permanent write-down and temporary write-down. Beside the contingent feature, there are other important features for CoCo. CoCo bonds can be senior bond, can be a Tier 2 bond, but most of them are Additional Tier 1. For almost all Additional Tier 1 CoCo, the issuer has sole discretion to pay the coupon. There are also some circumstances including an insufficient distributable item or payments exceed the maximum distributable amount, so that even if the issuer would prefer to pay the coupon, they are prevented from doing so. A cancelled coupon is non-cumulative. So if CoCo holders can’t receive interest, it can have a large impact on the value of the security as most CoCo bonds have a perpetual maturity structure. Like many other bonds, a CoCo generally is a callable bond. The difference with a CoCo is if an issuer intends to call the bond back, CoCo issuers must get consent from their respective regulators. Again, there is no formula to predict if the regulator will give their approval or not. Other than regular redemption, most CoCo bonds give the issuer the option to redeem the bond at par if there is tax event, capital event or rating event, or CoCo issuer has the flexibility to substitute or vary the contractual terms without prior consent from CoCo holders. All these add to the complexity of CoCo Bonds. CoCo provides investors, regulators, researchers and other professional firms valuable information to assess global banks’ health. It is a useful tool to analyze banks, leverage and the economy. All the players in the financial markets should understand the instruments. But it is not easy. To understand CoCo, researchers have to go through the complex contractual terms and to go through the complex financial results of the issuing bank. To make things worse, as a new asset class, the accounting treatment, its rating methodology, Issuers’ pillar II capital requirement and other legal issues are not fully established yet and also not tested. These uncertain external factors make CoCo an even harder object. To solve these problems, we developed this app. It is called "CoCo Monitor". In CoCo Monitor, we standardize CoCo notes and issuers’ information. With this app, our subscribers can gain access to the valuable information anytime anywhere with their mobile. Take CS 5.75 09/18/25 as an example. You can see on the top of page is the market price of this note. App users can set up a price alert here. For example, you can set up a bid price target 103. So when the bid price reaches 103, we will inform you via mobile push-through. Not only standardized information, we also provide users the specific information on each CoCO note. You can see here in the "General Information" that, although CS 5.75 Perp is issued out of Credit Suisse Bank, the trigger mechanism is actually linked to Credit Suisse Group. So it is the Credit Suisse Group that investors should monitor. It is a big difference between Credit Suisse Bank and Credit Suisse Group. In the "Trigger and Loss Absorption" area, we have a "Distance to Trigger" alert, which enable subscribers to set up a predetermined alert level. Let’s say users set a level 8%, 300bps above the trigger level 5%. So when Credit Suisse Group CET1 ratio drops close to 8%, we will inform our users and remind them of the risk be permanent write-down. You can also take a note on each bond page. So you can review it anytime you want. If you want to get the prospectus of CS 5.75 Perp, just click the button below and confirm your email and we will email you the prospectus for you to take a close look at the contract yourself. After reviewing the bond page, users can go to the issuer page. In this case, it is Credit Suisse Group page. In the "Latest Result" area, you can see the latest quarter results . One thing you need to know is the basis of these numbers. Are they fully-loaded numbers or transitional numbers. It makes a lot of difference. Because some CoCo bond triggers are calculated based on fully-loaded CET1 ratio like HSBC and Nordea while others are calculated based on phased-in CET1 ratio. By clicking the chart icon, users will be able to see historical data. For example, if you click the CET1 ratio chart icon, you will see the curve on Credit Suisse Group CET1 ratio from Q1 2014. Below the "Latest Result", there is regulation information. Users will see the capital requirement from the relevant authorities. This is very important to CoCo investors because this will determine whether the coupon distribution will be paid or cancelled. To help investors mitigate this risk, we also provide an alert function called “Buffer to Coupon Restriction” alert. For example, in ABN AMRO bank’s page, we can see the buffer to coupon restriction is € 5.1 billion based on Q3 2015 result, our subscribers can set € 2 billion buffer alert here. Once the buffer drops close to € 2 billion, we will notify our subscribers via mobile push through. After the regulation information, we provide the future targets. The global finance crisis changed the way banks communicate with the market. They are more transparent. Here you have the 2018 target for Credit Suisse Group. You can see the outlook of Credit Suisse Group. They will cut cost, increase capital, wind down bad business and grow profitable business. If executed all these actions will help build a healthier Credit Suisse Group, which in turn will make the CoCo unlikely to be bailed in. In addition to the bond and issuer information, CoCo Monitor also provides “News & Analysis”. We will provide our users the latest market news and deep analysis. The news and analysis will cover every aspect including: regulation, rating, legal, accounting, trading. Our subscribers will have access to this valuable information anywhere, anytime via their mobile. One app with all the information. We hope you find this app helpful. If you want to know more about our products, you can download the app from app store and start a trial. or you can contact us directly. Thank you very much for your time.



The concept was proposed by Professor Robert Merton in 1990 as a guarantee that gives holders "contractual right to seize the firm's assets (or its equity interest) whenever the value of assets is below the value of its guaranteed debt."[5] and later published in the Harvard Law Review in 1991.[6] These concepts may have served as inspiration to the instrument used during the Financial Crisis of 2007-08.

The trigger and the conversion rate

A contingent convertible bond is defined with two elements: the trigger and the conversion rate. While the trigger is the pre-specified event causing the conversion process, the conversion rate is the actual rate at which debt is swapped for equity.[7] The trigger, which can be bank specific, systemic, or dual, has to be defined in a way ensuring automatic and inviolable conversion.[8][9] A possibility of a dynamic sequence exists—conversion occurs at different pre-specified thresholds of the trigger event.[10] Since the trigger can be subject to accounting or market manipulation, a commonly used measure has been the market’s measure of bank’s solvency.[11] The design of the trigger and the conversion rate are critical in the instrument’s effectiveness.[12]


Contingent convertible bonds can take a variety of different forms such as a standby loan, a catastrophe bond, a surplus note, or a call option enhanced reverse convertible.[13][14]

Advantages and criticism

In the context of crisis management, contingent convertible bonds have been particularly acknowledged for their potential to prevent systematic collapse of important financial institutions.[15] If the conversion occurs promptly, a bankruptcy can be entirely prevented due to quick injection of capital which would be impossible to be obtained otherwise, either because of the market or the so-called recapitalization gridlock.[16] In addition, due to its debt nature, a contingent convertible bond constitutes a tax shield before conversion. Hence, as compared to common equity, the cost of capital and, consequently, the cost of maintaining a risk absorbing facility are lower. In case the trigger event occurs, conversion of debt into equity drives down company’s leverage.[17][18]

Also, contingent debt is said to have the potential to control the principal-agent problem in a two way manner—engaging both the shareholders and the managers. The greater market discipline and more stringent corporate governance are exercised as a result of shareholders’ direct risk of stock dilution in case conversion was triggered. An argument has been made that making managers’ bonuses in a form of contingent convertible debt instruments could reduce their behavior of excessive risk taking caused by their striving to provide investors with the desired return on equity.[19]

A critical benefit of contingent convertible debt that distinguishes it from other forms of risk absorbing debt is the effect of "going concern conversion". When the trigger is well chosen, automatic conversion reduces leverages precisely when the bank faces high incentives for risk shifting. Accordingly, this feature ensures a preventive effect on endogenous risk creation, unlike any other form of bank debt.[20] On the other hand, contingent capital in a form of convertible bonds remains a largely untested instrument causing fears as to its effects especially during periods of high market volatility and uncertainty.[21] The appropriate specification of the trigger and the conversion rate is critical to the instrument’s effectiveness. Some argue that conversion could produce negative signaling effects leading to potential financial contagion and price manipulation.[22] Lastly, the instrument's marketability remains doubtful.[23]

See also


  1. ^ Fixed Income Investments
  2. ^ Pazarbasioglu et al. (2011), p. 4
  3. ^ Albul, Jaffee & Tchistyi (2010), p. 4
  4. ^ Harrington & Niehaus (2004)
  5. ^ "The Financial System and Economic Performance". Journal of Financial Services Research. 1990-12-04.
  6. ^ "Distress-Contingent Convertible Bonds: A Proposed Solution to the Excess Debt Problem". Harvard Law Review. 104 (8): 1857–1877. 1991-01-01. doi:10.2307/1341621. JSTOR 1341621.
  7. ^ Albul, Jaffee & Tchistyi (2010), p. 3
  8. ^ Albul, Jaffee & Tchistyi (2010), p. 3
  9. ^ Pazarbasioglu et al. (2011), p. 24
  10. ^ Albul, Jaffee & Tchistyi (2010), p. 4
  11. ^ Albul, Jaffee & Tchistyi (2010), p. 3
  12. ^ Pazarbasioglu et al. (2011), p. 4
  13. ^ Retrieved on January 17, 2014
  14. ^ Pennacchi, Vermaelen & Wolff (2011)
  15. ^ Albul, Jaffee & Tchistyi (2010), p. 2
  16. ^ Duffie, 2010 as cited in Pazarbasioglu et al. (2011), p. 7
  17. ^ Flannery (2002)
  18. ^ Raviv (2004)
  19. ^ Pazarbasioglu et al. (2011), pp. 7–8
  20. ^ Martynova & Perotti (2016)
  21. ^ Pazarbasioglu et al. (2011), pp. 6–8
  22. ^ Sundaresan and Wang, 2010; Goodhart, 2010) as cited in Pazarbasioglu et al. (2011), p. 6
  23. ^ Pazarbasioglu et al. (2011), p. 6


This page was last edited on 10 November 2018, at 18:03
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