Abstract
Background: A variant of the contingent convertible bond, first proposed in 2011, is investigated: the Call Option Enhanced Reverse Convertible (COERC). Although issued as a bond, it converts to new shareholder’s equity if a bank’s market share of capital falls below a pre-specified trigger point. Aim: COERCs avoid the problems with market-based triggers (e.g. sell-offs and death spirals) due to panic and market manipulation. Banks that issue COERCs have less incentive to choose investments that may be subject to large losses and disincentive problems, associated with the replenishment of shareholder’s equity after market declines (also known as debt overhang) are also avoided. Setting: Proposed amendments to the COERC structure are suggested for the African market. Methods: The data used were simulated, stylised values for a standard COERC. No market parameters are required, such as equity or debt levels or market volatility. Details of the stylised example are provided in Table 4 and Table 5 in the ‘results and discussion’ section. Results: Both examples of floating coupons for COERCS would aid in the objective of issuing a security that is countercyclical in nature, as banks would avoid having to pay coupons in times of distress. Conclusion: In addition to the recommendations of the Basel frameworks, CoCos have been considered and proposed as an additional measure to promote counter cyclicality in terms of capital composition in banks.
Highlights
The credit crisis of 2008 triggered global financial distress – in banks
All figures stem from the stylised example assumptions set out in Table 4 for CoCos and moving on to Table 5 which sets out numerical assumptions governing Call Option Enhanced Reverse Convertible (COERC)
Interventions to combat the drainage of capital from banks include measures such as the countercyclical capital buffer (CCB), as well as adjustments to the quantity and quality of capital required from banks
Summary
The credit crisis of 2008 triggered global financial distress – in banks. One of the many suggestions put forward by global regulatory authorities was the proposal that banks should implement and install contingent convertible debt (CoCos), which automatically convert into equity when prespecified trigger levels are breached. These triggers could be accounting information based, market price based, or wholly decided by bank supervisors. Global CoCo issuance soared post the credit crisis (2009–2014): additional tier 1 capital CoCo issuance increased from US $2 billion in 2010 to $93 billion in 2014. Issued as a bond, it converts to new shareholder’s equity if a bank’s market share of capital falls below a pre-specified trigger point
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