Contingent Convertible (CoCo) bonds are loss absorbing hybrid instruments issued by banks.
Coco’s pay a high coupon, yielding 6% to 8% p.a., which is highly attractive for many institutional investors in the current environment of prolonged low- or negative interest rates. At the same time, CoCo bonds bear the risk of a significant loss when the issuing financial institution is facing a life-threatening situation. Once this happens, the CoCo can either be written down (in partial or full) or converted into equity.
The existence of such a life-threatening situation is typically measured in terms of a capital ratio such as the bank’s Common Equity Tier 1 (CET1) ratio falling below a pre-defined level. Practically, the trigger levels range in most cases from 5% to 8%.
The CET1 ratio is defined as a measure of a bank’s common equity capital expressed as a percentage of risk-weighted assets (RWA). The exact definition of the CET1 ratio varies across different jurisdictions, but in general, the calculation is according to the International Standards for Capital Adequacy Assessment commonly known as Basel III.
CoCo bonds play an important role in the new banking regulation that evolved in the aftermath of the financial crisis 2007/8.
Under the Basel III regulation, only loss absorbing instruments count as regulatory capital of a bank. CRD IV, the EU legislative package covering the translation of Basel III into prudential rules for banks in the European jurisdictions, takes further steps to improve the quality of banking capital.
Under CRD IV, Additional Tier 1 (AT1) Coco’s can account for 1.5% of the risk-weighted assets (RWA), while Tier 2 Coco’s can account for 2% of the RWA.
Total Volume of Tier 1 CoCo bonds
(in EUR Billion). Source: J.P. Morgan
The CET1 ratio is also a central pillar of CRD IV, e.g. within the stress test that the European Central Bank (ECB) imposed in November 2014 on all banks in the Eurozone.
The combination of regulatory pressure and investor demand for higher-yielding products leads to exponential-rate growth of the CoCo bonds market size.
Version 1.0 of TheMarketsTrust valuation, risk management and credit rating platform supports around 400 securities, most of these coming from European banks and Asia-Pacific banks.
These correspond to more than 95% of the issued CoCo bonds up to date. The remaining CoCo bonds that are not covered are “exotic” emissions of small volumes and/or highly illiquid emissions done on special purposes.
The covered securities are both Tier 1 and Tier 2 CoCo’s with a total volume of approximately EUR 300 Billion. Issuers are 148 banks from more than 130 banking groups.
Volume of supported CoCo bonds by Region
We intend to retain the almost 100% coverage of the CoCo bond market.
New emissions are added to our coverage soon after they are placed on the market, typically within a month or less.
Upon customer request, we are able to extend the coverage with further CoCo bonds as well as with bank fixed income securities with CoCo-like features. Live dealers online casino.