Regulation leads to expansion of the Coco market
Banks are required to hold sufficient capital to cover the loans that they provide, and they can use CoCos as additional Tier 1 (AT1) instruments to comply with their capital requirements. As a result, the European CoCo market has grown to EUR 182 billion in recent years (Figure 1). Following substantial issuances in 2014, the level of issuances decreased in the years 2015 and 2016, as several banks had already reached their desired volume of CoCos in 2014 and only few new market entrants opted for CoCo issuances. The stress in the CoCo market in early 2016 also depressed the number of new issuances. It emerged from concerns about the profitability of banks and uncertainty regarding coupon payments.
Annual issuance figures for CoCos (EUR 25 billion) are still lower compared with other types of bank bonds, including the senior unsecured and Tier 2 instruments (EUR 150 billion and EUR 40 billion, respectively). Tier 2 instruments are subordinated bonds, which can be used in addition to Tier 1 capital to meet the 8% capital requirement. As CoCos can be converted into shares or written down if a bank's capital ratio falls below a predetermined level, they carry higher and more specific risks for investors than other types of bonds. On the other hand, returns on CoCos also tend to be higher.