The Credit Suisse crisis has caused a particular speculative storm around contingent convertible bonds (Cocos), a complex financial instrument that all investors are looking at with concern and interest these days. At least momentarily and until the European Central Bank (ECB) offered clarification, this type of debt has become at times the most dangerous and problematic part of the financial system.
Coconuts are bonds generally issued by banks that, in the face of an adverse situation or a deterioration in solvency, are transformed into shares, which allows the entity to restore its capital. They are usually perpetual, with no expiration date, and worldwide they make up a market of about 250,000 million euros, since they are listed like many other financial instruments.
The decision on Sunday by the Swiss National Bank and the country's supervisor, Finma, to bypass orthodoxy in bank failure cases and establish a priority order in which coconuts are the first instruments to be liquidated caused a landslide. in the prices of these bonds, which spread on Monday in the form of uncertainty to the prices of the European banking sector.
The nervousness was justified. After the 2008 crisis, the Financial Stability Board (FSB) internationally established an order of victims of a bank failure to prevent taxpayers from having to assume it. The first barrier is the bank's capital and reserves, which is known as CET1, and which includes the shareholders. If the first firewall falls short, it goes to the second barrier, AT1, where the Cocos are, and if it is insufficient, it accesses TIER2, which is the subordinated debt. All this is called bail in, or internal rescue, which is the step prior to bail out, which is done with public funds.
The Swiss National Bank flouted these principles on Sunday, sacrificing Credit Suisse's Coconuts before shareholders, who had suffered a sharp decline in value but now at least will have UBS shares with appreciation potential. The Saudi National Bank, Credit Suisse's largest shareholder, with almost 10%, will save part of the investment.
This decision generated confusion and contributed to the collapse of European banks on the stock market on Monday, which was halted not only with reassuring messages from Christine Lagarde, but also with a statement from the ECB, the Single Resolution Board (SRB) and the Banking Authority European Union (EBA) in which it was recalled that, in the event of a possible intervention in the event of a crisis, the ordinary capital instruments of the entities would be the first to bear the losses, before the Cocos.
The stock market storm has subsided, at least for now for the banks, but it has not come to a halt in the Cocos price, which is still subject to great speculation due to the new risks surrounding this type of debt. There are large investors who, given the fall in value of coconuts, see good buying opportunities.
Credit Suisse's Cocos, worth around 17 billion euros, are trading near zero, but some speculators are buying them, according to Reuters, in a bet that the UBS merger will not go ahead or that the Swiss regulator may reverse your decision and not liquidate these types of products in the ransom.
The broker Southey Capital estimates that hundreds of millions of dollars have been traded in Cocos from the failed bank these days. Among the buyers there are also opportunistic firms with the intention of litigating with the Swiss authorities to recover the value of the bonds.
A Citi report warns that the difficulties in the bond market make it difficult for Asian banks to issue this type of debt, which in turn prevents them from strengthening their cushion against a possible crisis. Financial services firm Morningstar instead reassures the market by saying that the turmoil around the Cocos will be restricted to Switzerland because the European, British and Canadian authorities have already made it clear that their course of action in the event of a bank bailout will be different.
In the midst of the confusion, the US bank Goldman Sachs has issued a note in which it says that now there is a good opportunity to buy Cocos, which has contributed to the fact that the price of these instruments has recovered in the last hours, at least in Asia.
According to Bloomberg, of Hong Kong's 38 perpetual debt listing indices, 31 were appreciating today. The Cocos of one of the large Chinese banks, the Bank of Communications, are recording their biggest rise since 2020. The discount on this debt is so high that investors are now opting to buy it. "We see the recent weakness as an opportunity to add risk," says Goldman Sachs.
