What is Contingent Convertible?

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Contingent convertibles (CoCos) are debt instruments primarily issued by European financial institutions. These securities work in a fashion similar to traditional convertible bonds. They have a specific strike price that, once breached, allows the conversion of the bond into equity or stock.CoCos, also known as AT1 bonds, are high-yield, high-risk products. A CoCo is also referred to as an enhanced capital note (ECN). The importance of this hybrid debt security is that it carries specialized options that help the issuing financial institution absorb a capital loss.CoCos can help to shore up a bank’s balance sheets by allowing it to convert its debt to stock if specific, unfavorable capital conditions arise. They were created after the 2007–2008 global financial crisis to help undercapitalized banks and to reduce the potential for taxpayer-funded bailouts.

Definition

Contingent Convertible Bonds (CoCos) are debt instruments primarily issued by European financial institutions. These securities function similarly to traditional convertible bonds. They have a specific strike price, and once breached, they allow the bond to be converted into equity or stock. CoCos, also known as AT1 bonds, are high-yield, high-risk products.

Origin

CoCos were created after the 2007-2008 global financial crisis to help undercapitalized banks and reduce the potential risk of taxpayer-funded bailouts. The importance of these hybrid debt securities lies in their special options that help issuing financial institutions absorb capital losses.

Categories and Features

CoCos are mainly divided into two categories: accounting-based triggers and market-based triggers. Accounting-based CoCos are triggered when a bank's capital ratio falls below a certain level, while market-based CoCos are triggered when market indicators (such as stock price) reach a certain level. Their main features include high yield and high risk, as investors may face the risk of bonds being forcibly converted into equity under trigger conditions.

Case Studies

A typical case is Credit Suisse's issuance of CoCos in 2011, which helped the bank quickly replenish capital when its capital ratio declined. Another example is Barclays' issuance of CoCos in 2013, which provided additional capital buffers during market turmoil.

Common Issues

Investors may encounter issues such as misunderstanding the trigger conditions and experiencing significant changes in bond value during market volatility. A common misconception is that the high yield of these bonds implies low risk, whereas their high-risk nature requires careful consideration by investors.

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