Cocos for European Banks

Everyone agrees on the need for big changes to bank resolution mechanisms both in Europe and in the USA. The problems with bank resolution differ in Europe and the USA, and the appropriate solutions differ too. Coco bonds make great sense for the Eurozone but are less appropriate for the USA. European regulators need to think for themselves on cocos, not just ape the muted response of US regulators. Contingent convertible (coco) bank bonds have a trigger point (such as a minimum equity/asset ratio) which when reached immediately forces a conversion of the liability from a debt to an equity claim. So when the bank gets into trouble, junior-grade debt liabilities immediately disappear and are replaced by diluted equity. Coco bank bonds are a very partial solution (at best) to the TBTF bank resolution problem in the USA. For all but the very biggest banks, the harsh and effective resolution system in the USA can close and re-open troubled banks very quickly. This type of super-fast bank resolution will never happen in the fragmented multi-national banking system of the Eurozone. Also, the technical competence of bank oversight in the USA will never be matched across all seventeen countries of the Eurozone, some of whom have long histories of weak and ineffective bank regulation. Cocos can partly substitute for weak regulatory oversight by encouraging greater market discipline emanating from bank bondholders.  Cocos would fit well into the design of a politically-feasible banking union for the Eurozone. 

If the euro survives, some type of contingent convertibility for bank debts in the Eurozone is likely to be part of the new banking system.  Ireland as a small economy in the Eurozone would particularly benefit from a coco feature imposed on bank bonds, and should encourage this regulatory policy innovation.

16 replies on “Cocos for European Banks”

Banks appear to be legally allowed to postpone recognising losses – as a result equity is protected and if equity is protected then Cocos will never be converted.

A more interesting and important question that has to be answered is: When do banks have to recognise losses?

Coco’s are priced too expensively (10%+) at the moment to make them practical on a large scale basis.

“Cocos would fit well into the design of a politically-feasible banking union for the Eurozone. ”

It sounds very much like the Americans in 1944 deciding how Europe would look post war. A politically feasible banking union depends on what’s left standing and the war isn’t over yet.

Who would buy them? Insurance companies are de-risking to prepare for Solvency II
The market would come to a conclusion about E/A quicker than the regulator or the banks. If you put a market trigger in-say shares trading at less than 0.5x Book then hedge funds could drive the share price down and force dilutive conversions.

The main point about something such as the Coco if implement at local member state level within the Euro area – is that it would make life a lot easier for ECB – in that it would not have to manage so much rogue behaviour on the part of executives within the parliaments of the said member states.

What we have witnessed in Europe in the smaller peripheral countries in particular, is a situation whereby the sovereigns have begun to compensate for their own lack of monetary policy control levers – by co-opting their own national (supposedly private) banking systems – for the purposes of re-gaining control over local economic policy levers.

The intervention of some real banking regulation, in order to prevent the sovereigns within the Euro area, from co-opting their own national banking systems is what will be required.

What the Coco type of instrument does, is that it prevents executives within the parliaments of the members states from this instinctive response always, of converting private bonds into sovereign bonds, in order to maintain control by government over levers that they perceive are necessary in order to remain in control over local economic policy levers.

Something has to be done within the Euro area, to re-establish banking regulations position in between the state and the private banking establishments – and to avoid this conundrum – whereby banking systems are co-opted by the parliamentary executives, leaving regulation high and dry, because it would entail a non-elected (poorer political class) regulatory body needing to regulate an elected (higher political class) state executive branch.

All that is happening in the Euro area at the moment, is a political class war. The national banking infrastructure, is merely the battle field for the conflict at the moment, and that battlefield needs to be changed soon. BOH.

Btw, I don’t think that the battle within sovereign nations of the Euro area is over, by a long shot. Governments throughout the Euro area need to acknowledge that they are in denial, as to their inability to accept a loss of local monetary control levers. We all need to acknowledge that this battle is on going. But we need to move the battlefield off of its current stage, in order to protect citizens.

To be honest, I am aware of the arguments that there exist now, that monetary policy has become somewhat impotent. But one of the best arguments that I can think of for allowing local governments to set their own monetary policy – is that it gives them some lever that they can push and pull – and gives their PR consultants something to work with, to enable those governments to stand out on plinths and make announcements about the adjustment of economic policy levers.

When you remove that monetary policy lever from governments – they begin to experiment with the more dangerous and less well understood buttons and knobs that they can see on the control panel. At least with monetary policy, it gave them one big lever (albeit it wasn’t connected to very much), but it allowed governments to sustain some credibility for optics.

A bit like in former soviet times, in announcements of record breaking grain harvests – no bread on shelves etc. Governments need to be perceived to be doing something. If you take that away, things become very un-predictable. Until we can understand better how to give the local member state executives something useful with which to maintain control over their local economies, it is a mistake to take away that ‘big tool’ from them. BOH.

Movie Reference: 1980s movie, War Games. Where they ‘took human beings out of the loop’, and handed control over to the intelligent ‘whopper’ super computer, to respond more effectively to on-coming Russian nuclear strike attacks.

That is what has basically happened in Europe in the 2010s. It handed control over operations to young kids in their bedrooms with computers. BOH.

Coco bonds sounds like a very good idea to me. Particularly if combined with the new capital requirements. Euro or no euro.

If banks fall below certain capital ratio’s, then trigger the coco bonds.
It is surely better than triggering an automatic downgrade of sovereign bondholders, by placing the burden of losses or capital shortfalls onto the state.

@ Tull

do you think Solvency 2 will survive the maelstrom? There’s too much stuff in it that is hardcoded IMO. Starting with the definition of “risk free”.

I am no expert but it seemeed that both SII was forcing life companies to buy less risky lower yirlding assets for for their investment portfolios, which threatened their ability to meet some of their contractual obligation to clients or at least lower those to newer coustomers. IT seems that the NOrdics are walking away from part of the package. IS that why the bund has sold off-the risk free bid is abating for this and other reasons.

Similarly the Brits also seem to be softening their hawkish stance on capital and liquidty for their banks-cheaper fuunding, lower liquidity, higher leverage (in line with BIII.

To all the readers — I will fix up the formatting (lack of paragraph markers) in the entry when the blog server’s technical problems get fixed. The editing software is not working properly today. So everyone must use their imagination and add appropriate punctuation.

The current coco bonds in issue for this purpose seem to be referred to as “sovereign bonds”.

There is some merit to Coco bonds for the Eurozone as a short term solution to the debt crisis. However, the problem is that money is created in line with debt and money is canceled out of existence through loan repayments. Coco bonds can buy some time but at some point we’re going to have to introduce a source of debt free money for our economies.

Households have always been increasing borrowers but since mortgages have hit the natural limit of taking two careers to repay we can’t rely on them to create enough money for the economy to function well any more.

@ All

This well informed French commentary sums up the likely level of agreement to be found between the two major players. Anything that smacks of the “magic solution” emerging from the groves of academe is almost by definition excluded, the one possible exception being the idea of a redemption fund proposed by Merkel’s own economic advisers.


“Paris et Berlin devraient finir par s’entendre. Ils n’ont pas le choix. Tous les vieux routards de l’Europe le disent, à l’instar d’un Daniel Cohn Bendit, pour qui le Merkhollande va se former, “par la force des institutions”.”

The old force of institutions has not done very well so far in this debacle.

The EU and EC institutions have been sidelined.
The newer ECB, has concerned itself with its primary mandate of ‘inflation’ and doing what it is told by the Bundesbank. That is when it was not otherwise engaged in protecting selected creditors and changing regimes.

Even if the article is correct it argues mainly along the lines of dependence of Germany and France on each other, that ‘reconciliation’ may not necessarily have the interests of other European ‘partners’ at its core.

Any objective observer has to conclude that the EZ has made an absolute hames of Europe in dealing with this crisis.
The only country that seems to disagree with this is Germany and her view is not an objective one as she is the main beneficiary of the chaos.


Google interestingly translates

“En fait, il y a deux chancelières, la leader toute puissante sur laquelle le monde a les yeux rivés pour sauver l’Europe.”

“In fact, there are two muffs, the leader in all things from which the world is watching to save Europe.”


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