Don’t understand “coco bonds” but afraid to ask? Anyone concerned about how Europe will tackle its mountainous debts — including in Greece — is advised to brush up quickly.
Cocos, or “contingent convertibles”, are bonds whose features change according to the issuers’ circumstances. Largely unnoticed beyond a few specialists, Europe has pioneered bank cocos, which convert into shares or are wiped out when issuers hit trouble. They are liked by regulators and cash-strapped European governments because they provide financial cushions in crises — and reduce the cost to taxpayers of bailing out banks.
Coco bonds have now come of age. Moody’s this week reported $288bn in cocos had been issued by banks it rates since an inaugural issue by Lloyds in 2009, and predicted issuance in 2015 would match last year’s $174bn. Europe had accounted for more than half of issuance — but the market was being increasingly driven by banks in Asia, especially China.
For investors, coco bonds offer temptingly higher yields, — although there are serious worries about whether their riskiness is priced accurately. More broadly, cocos are helping Europe manage its outsize banking system. They offer a different way of distributing risk between creditors and debtors, and potentially of making bank crises easier to resolve and less politically controversial.
Credit Suisse last year even started to pay part of its top bankers’ deferred bonuses in coco bond equivalents — ensuring their interests lie in the bank’s long-term stability.
So could the coco concept be developed by other issuers besides banks — including governments? The high-stakes drama over Greece’s financial plight and eurozone membership has served one positive purpose, stirring debate over how Europe will manage exceptional indebtedness when economic growth is sluggish and inflation low.
Europe has a creditor-friendly tradition, whether borrowers are consumers, businesses or governments. Bankruptcy laws are less flexible than in the US and the idea of a sovereign debt restructuring horrified European policy makers until Greece’s work out in 2012. Such rigidity imposes financial discipline, but arguably makes acute debt crises much messier and harder to resolve.
Yanis Varoufakis, Greece’s new finance minister, has suggested one way of shifting the balance. He is pushing for part of his country’s debt to be swapped for bonds linked to gross domestic product so Athens’ obligations vary according to how well the Greek economy performs. GDP-linked bonds have long been discussed by economists. But so have “sovereign coco” bonds — and their proponents argue they could prevent high-stakes Greece-like crises from erupting in the first place.
In March 2011, Axel Weber, then president of Germany’s Bundesbank, proposed clauses in eurozone government bonds which would automatically extend their maturity by three years if a country had to be bailed out by European institutions. Bank of England economists have made similar proposals, suggesting sovereign cocos that “pop” when the International Monetary Fund is called in.
© Financial Times
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