A practical use of the trigger embedded in CoCo bonds: Part II

Francisco Ciancetta

The concept of the contingent convertible (CoCo) bond embedding a trigger was initially devised for restructuring purposes. However, regarding non-financial corporations, the initial intention seemed to deviate from more classical financial purposes. According to the Liberadzki brothers, the first prototype of CoCos issued by corporations was devised during the early 1990s by a study group at Harvard. The rationale behind it was to provide an instrument for restructuring distressed companies which had issued large quantities of so-called junk bonds. ¹ This group of Harvard scholars highlighted that an automatic trigger converting junior bonds into a predetermined number of shares could restructure a company without using conventional restructuring tools, which are very expensive. ² The research showed that the mechanism embedded into a CoCo works like a tool for distressed companies. They posed the example of an issuance of $200 million worth of CoCos. When the trigger is hit, the bonds will be compulsorily converted into a predetermined number of shares according to a premium conversion. In accounting terms, the amount will be counted as $200 million worth of debt. Once the trigger is hit, the amount will decrease to 0 on the right hand side of the balance sheet and an equal amount going from 0 to $200 million will be counted on the left side of the balance sheet as equity. ³