Contingent Capital Securities : Problems and Solutions

We discuss the current funding practice of banks, looking at the typical capital structure of banks, examining where CoCos will likely fit within this structure and giving examples of recently issued CoCos. We explore the key design choices of bank CoCos analysing the potential problems that each present. Based on this analysis we find that existing practice is not ideal. Lloyds, Rabobank and Credit Suisse have all issued CoCos with a backward looking accounting based trigger whereas we recommend a forward looking market based trigger because a market based trigger is more likely to detect an evolving crisis. Moreover, we suggest that the market based trigger be based on a trailing average of the bank's stock price to reduce the likelihood of stock market manipulation by shareholders and by CoCo holders alike. We also favour a conversion mechanism that relates the trigger price to the conversion price as this mechanism will reduce the uncertainty for CoCo holders and shareholders alike as well as providing a method to control burden sharing. Finally, we recommend that the CoCo coupon rate be made adjustable in some way so that the coupon rate can reflect the changing market conditions