Understanding CoCos: What Operational Concerns & Global Trends Mean for U.S. Policymakers

Abstract

Contingent convertible capital instruments (CoCos) are debt-like securities treated as bank regulatory capital that, upon a trigger event occurring, either convert to equity or are written-down. While regulations and tax and accounting rules preclude U.S. CoCo issuances, since 2009, many foreign jurisdictions have embraced CoCos, largely via Basel III-related rules. As a result, over $300 billion in CoCos have been issued. This working paper presents analyses of the buy-side and sell-side markets for CoCos, trends in the global CoCo market from its inception in 2009 through the CoCo market turmoil of early 2016, and CoCo-related risks facing issuers, investors, and policymakers in the years ahead. Academic literature on CoCos is examined, and the theoretical costs and benefits of various CoCo structures are discussed. Broadly, this working paper aims to assess (1) whether or not U.S. banks should be allowed or required to issue CoCos to meet regulatory capital requirements; and (2) how Congress and/or U.S. regulators should think about establishing regulations that set forth the permitted structural qualities of these instruments, thus enabling CoCos to be issued by U.S. banks. The benefits, costs, risks, and operational considerations of enabling CoCo issuances by large U.S. banks are assessed not just broadly, but also in the context of a particular legislative proposal by U.S. House Financial Services Committee Chairman Jeb Hensarling which would grant regulatory relief to banks meeting a high, but simple capital threshold.