what are contingent convertibles cocos 
contingent convertibles cocos are debt instruments primarily issued by european financial institutions these securities work in a fashion similar to traditional convertible bonds they have a specific strike price that once breached allows the conversion of the bond into equity or stock cocos also known as at1 bonds are high yield high risk products a coco is also referred to as an enhanced capital note ecn the importance of this hybrid debt security is that it carries specialized options that help the issuing financial institution absorb a capital loss cocos can help to shore up a bank s balance sheets by allowing it to convert its debt to stock if specific unfavorable capital conditions arise they were created after the 2007 2008 global financial crisis to help undercapitalized banks and to reduce the potential for taxpayer funded bailouts understanding contingent convertibles cocos cocos are designed to automatically cover bank losses and aid them in satisfying additional tier 1 at1 and tier 2 t2 regulatory capital requirements imposed by basel iii there is a significant difference between bank issued contingent convertibles bonds and standard convertible bonds convertible bonds have bond like characteristics they pay a regular rate of interest and have seniority in the case of the underlying business defaulting these debt securities also allow the bondholder to convert the debt security into the issuer s common stock shares at a specified strike price this gives investors the potential for share price appreciation the strike price is a specific stock price that needs to be reached for the conversion to occur investors can benefit from convertible bonds since the bonds can be converted to stock when the company s stock price is appreciating the convertible feature allows investors to enjoy both the benefits of bonds with their fixed interest rate and the potential for capital appreciation from a rising stock price contingent convertibles expand on the concept of convertible bonds by modifying the conversion terms as with the convertible bond investors receive periodic fixed interest payments during the life of the bond but cocos automatically create a loss for investors if the issuer s capital drops under a specific level reaching these points of normally 7 or 5 125 of total risk weighted assets can cause three potential results for investors broadly the trigger can take several forms including the price of the underlying shares the bank s need to meet regulatory capital requirements or the demand of a managerial or supervisory authority the use of cocos has not yet been introduced in the u s banking industry background of cocoscontingent convertibles became popular as an aid to financial institutions in meeting basel iii capital requirements basel iii is a regulatory accord outlining a set of minimum standards for the banking industry its goal was to improve the supervision risk management and the regulatory framework for the critical financial sector as part of the standards a bank must maintain enough capital to be able to withstand a financial crisis and absorb unexpected losses from loans and investments the basel iii framework tightened banks capital requirements by limiting the kind of capital that they could include in their various capital tiers and structures one type of bank capital is tier 1 capital the highest rated capital available to offset bad loans on the institution s balance sheet tier 1 capital includes retained earnings an accumulated account of profits as well as common stock shares banks issue shares to investors to raise funding for their operations and to offset bad debt losses cocos act as additional tier 1 capital at1 helping european banks to meet the basel iii requirements they allow a bank to absorb the loss of underwriting bad loans or other financial industry stress 