The Handbook of Hybrid Securities: Convertible Bonds, CoCo Bonds and Bail-In

3 Contingent Convertibles (CoCos)

Contingent convertibles are the newest member in the family of hybrid financial instruments and deserve everybody’s attention. After a reluctant start, yield-hungry investors were very keen early 2013 to invest in these bonds. This chapter provides a detailed anatomy of the structure of these bonds, their inherent risks, and the regulatory climate in which they were conceived.

3.1 INTRODUCTION

Contingent convertible notes (CoCos) made a very modest entry into the financial landscape in November 2009, when the Lloyds Banking Group offered the holders of some of its hybrid debt the possibility to swap these holdings into a new bond with contingent conversion features [68]. A CoCo stands for a bond that will be converted into equity or suffers a write-down of its face value as soon as the bank gets into a situation where it might, for example, not have enough regulatory capital. This feature encompasses the loss-absorbing capacity of the CoCo bond. As soon as such a situation occurs, the mechanism is automatically triggered. Triggering the conversion of the bond into shares or activating the write-down of the face value takes place when the bank is still a going concern. This constitutes a major difference from bail-in capital, where the loss absorption kicks in when the bank fails. Contingent capital is a going-concern solution whereas bail-in capital is a gone-concern instrument.

This conversion into shares creates a dilution for the existing ...