Cuckoo for CoCos
19 November 2014 London
Image: Shutterstock
Financial institutions across Europe have flocked to contingent convertibles (CoCos) in order to shore up their balance sheets analyst at Markit Relte Schutte.
The rise of this new hybrid equity/debt instrument could also, according to Markit, drive increased securities lending demand as market participants hedge their exposure to their bond instruments being converted to equity.
The hybrid nature of CoCos opens the door for investors to hedge their equity exposure in the event of a CoCo conversion.
As CoCos are similar to writing a put, the hedge would be to sell the reference equity short ahead of an impending conversion.
According to Schutte, this is not prevalent among the current crop of CoCo issuing firms, as none of them see any significant demand to borrow in the securities lending market.
The most shorted CoCo issuer is Credit Suisse, which has 1.5 percent of its shares out on loan, a number that is considerably below the market average.
Schutte commented: 鈥淟loyds Banking group, for example, did not see any change in its demand to borrow despite issuing over $8.6 billion of CoCos at the start of [April 2014].鈥�
鈥淭his represents roughly a tenth of the company鈥檚 current market cap and any significant hedging activity would have lifted the proportion of Lloyds shares out on loan above the 0.5 percent, which it has seen over the last 18 months.鈥�
The value of outstanding CoCo issuances has increased significantly in the 20 months since Basel III鈥檚 initial rollout.
The current notional amount of global CoCo securities tracked by the newly launched iBoxx Contingent Convertible Index Family now stands at $79 billion as of the end of September, which is nearly four times the amount seen at the start of the year.
CoCo issuance has been driven by large European financial institutions, according to Schutte, with an average market capitalisation across the 21 issuing firms of $40 billion.
On aggregate, these firms have issued CoCos worth 7 percent of their current market capitalisation.
The rise of this new hybrid equity/debt instrument could also, according to Markit, drive increased securities lending demand as market participants hedge their exposure to their bond instruments being converted to equity.
The hybrid nature of CoCos opens the door for investors to hedge their equity exposure in the event of a CoCo conversion.
As CoCos are similar to writing a put, the hedge would be to sell the reference equity short ahead of an impending conversion.
According to Schutte, this is not prevalent among the current crop of CoCo issuing firms, as none of them see any significant demand to borrow in the securities lending market.
The most shorted CoCo issuer is Credit Suisse, which has 1.5 percent of its shares out on loan, a number that is considerably below the market average.
Schutte commented: 鈥淟loyds Banking group, for example, did not see any change in its demand to borrow despite issuing over $8.6 billion of CoCos at the start of [April 2014].鈥�
鈥淭his represents roughly a tenth of the company鈥檚 current market cap and any significant hedging activity would have lifted the proportion of Lloyds shares out on loan above the 0.5 percent, which it has seen over the last 18 months.鈥�
The value of outstanding CoCo issuances has increased significantly in the 20 months since Basel III鈥檚 initial rollout.
The current notional amount of global CoCo securities tracked by the newly launched iBoxx Contingent Convertible Index Family now stands at $79 billion as of the end of September, which is nearly four times the amount seen at the start of the year.
CoCo issuance has been driven by large European financial institutions, according to Schutte, with an average market capitalisation across the 21 issuing firms of $40 billion.
On aggregate, these firms have issued CoCos worth 7 percent of their current market capitalisation.
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