Fixed income
CoCo bonds, or contingent convertible bonds, are a type of hybrid debt instrument primarily issued by financial institutions. They combine features of both debt and equity and are designed to enhance a bank's capital structure while protecting it against financial distress. These bonds are part of the regulatory framework introduced after the global financial crisis to improve banks' resilience during economic downturns.
How CoCo bonds work
CoCo bonds include a built-in trigger mechanism that activates under certain, pre agreed conditions. If a bank’s capital ratio falls below a specified threshold, the bonds automatically convert into equity or suffer a write-down of their principal value. This conversion mechanism helps banks absorb losses and boost their capital base without requiring external bailouts.
Investor appeal and risks
CoCo bonds offer higher yields compared to traditional bonds, compensating investors for their elevated risk. However, they with the higher yield comes greater risk, including regulatory uncertainty, market volatility, and the potential for loss during financial stress.
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Role in financial stability
CoCo bonds play a critical role in strengthening financial stability by ensuring that private investors bear part of the losses during a crisis instead of taxpayers. They also provide banks with a flexible capital-raising tool that aligns with regulatory requirements, making them an important component of the modern financial system.
