Barclays bond a key test for cocos market Big, bold and with the ability to wipe out holders if it hits the trigger, Barclays" contingent capital bond issue last week drew a whopping $17bn order book from investors in Asia, the US and Europe as well as a huge amount of market interest. Yet just over a week after the launch of the first high-trigger total-loss bond by a bank and with investors muttering over the bond's weak performance since issuance, the question is whether the $3bn issue will encourage more banks to follow the Barclays format. More than 500 fund managers, insurers, private banks and other investors took part in the Barclays issue, attracted by the 7.625 per cent interest rate on the 10-year bonds at a time when many fixed-income investors are chasing yield. The Barclays deal is seen as a key test for a nascent market that many agree has to grow if financial institutions are to meet new regulations governing how much capital banks must hold in crisis situations. Banks have long been expected to meet those regulatory targets by issuing variations of contingent convertible bonds, dubbed cocos, which developed after the 2007-08 crisis as a way for banks such as Lloyds and RBS to boost capital. But until recently, lack of regulatory clarity in Europe has hampered issuance. The Barclays deal was aided by recent guidance from the Bank of England and the Financial Services Authority on how much capital banks must hold. But some analysts and investors remain sceptical about certain aspects of the high-trigger total loss structure adopted by Barclays. In contrast to most of the cocos issued since 2009 that convert to equity once a pre-agreed financial trigger is breached, the Barclays notes write down to zero should the lender's common equity tier-1 ratio fall below 7 per cent. Some investors question whether the yield on the Barclays issue is adequate to compensate for the tail risk. More importantly, they say the issue upsets the normal hierarchy of the capital structure as bondholders would be left with nothing should the bank hit the trigger, even as the bank remained a going concern. "The fact that as bondholders you could find you are written off completely while shareholders still have a hold is a bit of an issue," says Steve Hussey, head of financial institutions credit research at AllianceBernstein. Such a structure assumes that a bank has a large enough buffer before the trigger is set off. The worry for investors would be whether that could change. "Apparently, some investors prefer getting written off to being converted to equity," says Robert Montague, senior financials analyst at ECM. These instruments share the same downside risk as equity but none of the upside. Despite his reservations, he believes other banks will inevitably look to cocos as they race to meet new regulatory requirements on contingent capital. Barclays Research estimates that while the tradable market for cocos is still modest, with only €19bn of securities still outstanding, the market could exceed €400bn. What form those cocos take, or even if cocos will be used at all, remains to be seen. Standard Chartered, for example, has continued to issue old-style instruments. And while demand for the simplicity of the Barclays bond was high, Credit Suisse and UBS have issued different versions of the contingent capital format this year as part of their effort to meet tough new capital requirements set out by the Swiss regulator. The regulatory guidance that helped the Barclays deal will help other UK banks, with HSBC seen as a possible contender to issue contingent capital given that it has strong core capital and total capital levels. Nordic banks could follow. But other jurisdictions are still waiting for the fine detail from their own regulators. Some banks, meanwhile, will find other ways to meet regulatory targets. Many banks have been active in using buybacks or exchanges of capital instruments to create profits and core tier-1 [capital]. The advantage of this is that you can do this on a wide range of capital securities," says Vinod Vasan, head of the European debt capital markets financial institutions group at Deutsche Bank. Mr Hussey says that while he expects to see more coco-type deals, some investors will continue to find it difficult to price notes that lie somewhere between equity and tier-2 capital. The equity conversion format appeals more to us and also with a different trigger point . . . Let's hope others go for the Swiss format," he says. It is clear that cocos are not going to be a one-size-fits-all product for banks.