Does the CoCo Market Have Faith in Regulators?

As part of Credit Suisse AG’s takeover by UBS AG, Credit Suisse’s contingent convertible bonds (or cocos) were written down to zero, while equity holders walked away with more than USD 3 billion. As explained in a previous blog post, this write-down risk may have been anticipated. Nonetheless, this so-called “inversion of the capital structure” led to an outcry among coco investors, prompting regulators outside of Switzerland to issue assurances that such a write-down would not happen in their jurisdictions.¹

But the point of cocos is to absorb losses before a bank becomes insolvent, leaving regulators’ proclamations at odds with cocos’ stated purpose. In fact, if the market believed these statements, cocos should be priced the same as any other subordinated bond.

But coco spreads remain significantly higher than those of subordinated bonds, suggesting a lack of confidence in European regulators’ assurances. As shown in the exhibit below, the spread premium of cocos over subordinated bonds (coco premium) spiked on March 20 after the collapse of Credit Suisse. Although it has subsided in subsequent days, it remains significantly higher than before the bank’s collapse.