The Essentials of Risk Management, Second Edition, 2nd Edition

Appendix 3.5

CONTINGENT CONVERTIBLE BONDS

Contingent convertible bonds, known as “CoCos” or “CoCo bonds,” are bonds issued by a bank or an insurance company that convert into common equity, or are subject to a write-down, at prespecified trigger levels as soon as the bank enters a life-threatening situation. Conversion, or the write-down, happens via a predefined trigger mechanism—e.g., when core tier 1 capital (CT1) falls below 5 percent.

Contingent capital can be viewed as a form of catastrophe insurance. When the bank is in a stressed situation, with a high risk of default, investors provide automatic loss-absorbing capital, with the debt being partially canceled or converted into common equity.

Conversion into common equity creates dilution ...