What are CoCos? Investing Explained

In this series, we bust the jargon and explain a popular investing term or theme. Here it’s CoCos.

A type of breakfast cereal?

CoCos is shorthand for contingent convertibles. These securities – which are a blend of a bond and a share – were devised in the wake of the global financial crisis.

The aim was to provide a buffer for the finances of banks and thus limit the possibility of future government-mounted bailouts – for which taxpayers foot the bill. CoCos can be converted into shares of the bank, if its capital falls below certain levels.

Which banks issue them?

Those in the UK and the rest of Europe, including BNP Paribas, Barclays, HSBC, Lloyds, NatWest, Santander and UBS. US banks mostly do not.

Who invests in them?

Such has been the growth of the CoCos market that, earlier this year, it was estimated to be worth $275billion, with the bulk of this being held by financial institutions who like their high yields. These institutions considered CoCos to be risky, but not excessively so, although recent events have caused them to reassess this viewpoint.

And these events are?

Huge doubts have arisen over the value of CoCos following the takeover of the collapsed Credit Suisse by UBS, another Swiss banking giant.

Finma, the Swiss financial watchdog, ordered that the $17billion worth of AT1 bonds issued by Credit Suisse should be written down to zero as part of the takeover.

Credit Suisse shareholders – who usually rank below bond holders in such situations – are to receive some money, $3.23billion.

But holders of CoCo bonds will get nothing. The fine print of these particular bonds is said to have permitted a total write-down, although holders appear to have been unaware of this. They now plan legal action against Finma.

What’s been the response?

The Bank of England and European regulators say that they would observe the usual hierarchy if a bank failed, with shareholders, rather than bondholders, bearing the brunt of the losses.

Nevertheless the wipe-out of the Credit Suisse bonds has caused alarm, with prices of other banks’ bonds in the same category falling sharply.

Their yields have doubled (when the price of a bond tumbles, its yield rises).

The fallout has spread to bank shares. Bill Winters, chief executive of Standard Chartered said that the move has ‘profound’ implications for the way banks are regulated.

Do CoCos have a future?

Experts have called the CoCos market a ‘busted flush.’

In a letter to the Financial Times, Theo Vermaelen, Insead business school professor of finance, wrote that although CoCos were meant to keep a bank alive, they had proved to be ‘instruments to facilitate a well-structured funeral’.

What happens next?

This is a moment of anxiety about banks. The Credit Suisse collapse came in the wake of the failure of the US Silicon Valley Bank. In the US concern has shifted to First Republic Bank and in Europe to Deutsche Bank. Against this background, banks may find it more expensive to raise capital which would hit their profitability. They may also be more constrained in their lending.