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Opinion

CoCos: Hybrid deals highlight investor confusion

Until the exact nature of the rules is clear, investors will continue to find hybrid bank capital a challenge.

The contrasting recent experience of the two large Swiss banks in the contingent convertibles market reveals the extent to which it is still very much a work in progress. Two years after the instruments were first launched, confusion still reigns – even about what a CoCo is. This was evident in the marketing of UBS’s low-trigger CoCo in February where investors seemed unclear as to whether to assess the deal as a new-style lower tier 2 with contractual write-down or as a contingent convertible. Indeed, it seems that there was no contingent language on the front page of the offering circular of the issue at all. The shaky performance of the deal since launch – it fell three points immediately and has yet to regain par – might be a reflection of straightforward confusion over what it actually is.

When Credit Suisse came to the market in mid-March the story was very different. This was a high-trigger deal, much smaller in size and issued in Swiss francs. But there was no confusion over whether it was a CoCo or not.

While the merits of equity conversion versus permanent or temporary write-down are well rehearsed, new-style hybrids under Basle III are getting a choppy reception from the market. At the end of March Macquarie Bank issued a $250 million hybrid tier 1 deal via Credit Suisse, HSBC, JPMorgan and Macquarie that fell well short of its $500 million target. A source at one of the leads partly attributes this to the presence of a dividend stopper and points out that under harsher new rules the contractual protection for coupons that used to be there no longer is. "Investors need to look at management and whether they will preserve the waterfall," he says. Others away from the deal say that it was simply too complicated.

The nature of the conversion trigger also continues to bedevil the hybrid market. The European Banking Authority’s board of supervisors releases a consultation paper on its technical standards for hybrids in April, and the market is hoping that this will provide some much-needed clarity. The new rules envisage inclusion of another trigger at the point of non-viability but give scant indication as to what the point of non-viability will be. A second trigger certainly muddies the waters for low-trigger CoCos, as it is likely to be tripped before the capital ratio trigger is. Observers argue that there was good logic to the UBS deal being marketed as a tier 2 deal – if you are about to breach a 5% trigger on a core capital of 13% the regulator is very likely to have got involved already. The exact mechanism by which these deals will be triggered – and what happens when they are – is still very far from clear and the market will continue to be hobbled until it is.

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