Basel hits market for CoCos
THE size of the potential market for contingent convertible bonds (CoCos) in the UK has shrunk by two thirds following a decision not to allow banks to count the instruments as capital cushions, according to analysis by Bank of America/Merrill Lynch.
Having previously estimated that the market for CoCos could be worth between £44bn and £88bn, BoA/ML’s Daniel Bell has said that the decision by the Basel III committee, which is developing new rules for capital requirements, will cut down the potential market by two thirds.
His original estimate was based on the assumption that regulators would demand a two to four per cent capital surcharge for systemically important financial institutions (SIFIs), which could have been filled by CoCos.
But the Basel Committee have published new guidance on the surcharge that excluded the use of CoCos, despite having praised the instruments repeatedly over the last year.
The committee also imposed a capital surcharge of up to 2.5 per cent, over and above the seven per cent core tier one capital requirement, for as many as 30 of the world’s biggest banks.
It also reserved the right to impose a further one per cent surcharge – taking the total capital requirement to 10.5 per cent for some banks. SIFIs will only be able to use the bonds to fulfil a small portion of the requirements.
Bell said the Basel III decision is disappointing: “There seems to have been enough concern raised about so-called ‘death spiral’ issues to push members into a preference for common equity.” The “death spiral” is a fear that when a coco converts into equity, it could push investors into a panic and have a counter-productive effect.
But Bell argues: “If properly designed, a CoCo is really just a back-stop to a failed rights issue. If you have a CoCo to fill that void, surely that’s better than not having one?”
Analysts have suggested that the new Basel III guidelines could set off a wave of financial capital raisings worth upwards of €60bn.