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Martien Lubberink argues banks' contingent convertible securities should be sold in denominations of $100k to protect vulnerable investors

Martien Lubberink argues banks' contingent convertible securities should be sold in denominations of $100k to protect vulnerable investors
Bank hybrid offers are very risky and complex and are designed to protect the banks. Even advisers may not understand the risks - they could make a mess of some retail investors.

By Martien Lubberink*

This week, the Commonwealth Bank of Australia (CBA) announced its plans to issue a A$2.6 bln CoCo bond to the general public.

Despite the innocuous name - PERLS VII - this CoCo bond is packed with warnings: This is a Contingent Convertible bond, it may self-destruct when CBA gets into trouble.

CBA is in good company when it warns prospective investors about the dangers of investing in CoCos.

Just a month ago, three European financial regulators warned banks and insurance companies to tread carefully when marketing CoCos.

Shortly after this warning, UK’s Financial Conduct Authority banned selling CoCos to the mass retail market altogether.

However, I am afraid that these warnings will not work. The text below explains why.

I will also offer a solution that may prevent future CoCo disappointments.

Mixed messages

The main reason why warnings may not work is a misunderstanding about the purpose of CoCos.

To be frank: CoCos aren’t there to help you make money. Instead, their primary objective is to absorb losses.

This to help the issuing bank survive and with it the financial system.

What makes this misunderstanding worse is the complexity of Cocos and the role of bank regulators.

CoCos are complex. Just read the prospectus of the PERLS VII, and agree with me that understanding these securities requires a high level of education.

Only true experts will be able to make an informed decision about CoCos.

Unfortunately, you cannot expect your financial advisor to be a competent expert on CoCos.

Given that his incentive is to sell these securities, whenever he feels uncertain about a specific feature of a Coco, he will likely err on the side of his wallet.

He can do that, because the warnings protect him.

Be advised though, you and your advisor may not understand these warnings correctly.

On top of the complexity of CoCos, their risks are communicated inadequately. For example, the PERLS VII presentation document warns prospective investors about many risks. But it also sports compelling evidence of CBA’s strong capital position: This is one of the best capitalised banks on the planet, what could ever go wrong?

In this context of complexity, greedy advisors, and poor marketing, regulators should offer some guidance.

However, their role may not be well understood. For example, investors notice that the bank regulator closely watches CoCos.

In addition, bank regulators are involved in managing these securities. In the case of the PERLS VII, the Australian regulator APRA may ask CBA to convert them into (low value) ordinary shares if it thinks CBA’s ability to survive is uncertain. In the case of ASB’s Tier 2 notes issued in March, the notes may be written off at the behest of the supervisor.

The current regulatory involvement in CoCos is therefore deceptive.

It creates an appearance of the regulator supporting them.

Investors may interpret this as the regulator being on their side.

In reality, this is not the case: the investor’s interest and that of the bank regulator diverge fundamentally. The regulator backs CoCos because of their role in protecting the financial system. To safeguard the safety and soundness of the financial system, the regulator may require a struggling bank to write-off your investment.

In other words, as soon as you invest in a Coco, you promise to save the issuing bank as well as the financial system.

Also if you look at how CoCos are created, then you should realise that you are up against powerful interests.

Each Coco is uniquely defined by an underlying contract. This contract is the result of lengthy negotiations between the bank, its platoon of expert advisers (lawyers, accountants, financial wizards, and tax specialists) and the bank regulator. Their joint interest is to make sure that the CoCo absorbs losses in case a bank gets into heavy weather.

Again, it is not the bank regulator’s interest to make sure you receive a high return.

On the contrary, it is about your investment being wiped out when the bank runs into trouble.

A solution

CoCos are very risky and complex – by now that should be clear. And although the regulators rely on warnings to prevent them to be mis-sold to the public, these warnings may not be fully appreciated. Complex product features, poor marketing, greedy advisors, and mixed messages from regulators may render the warnings ineffective.

Moreover, we know that financially illiterate investors in particular may not read or understand the warnings. They may be blinded by the high yields that CoCos offer.

Therefore, instead of warnings, let me suggest the following solution.

As an effective way to mitigate the risk of CoCos being offered to vulnerable investors, banks should issue them at high denominations, e.g. $100,000 per note.

An investor willing to fork out such an amount should be able to hire an expert who understands these securities and can make an informed decisions about them.

Given the simplicity of the solution and the risks attached to Cocos, I wonder why regulators still allow them to be sold to the general public.

Returning to Queen Marie Antoinette’s infamous words, even she would realise that CoCos are riskier than cake.


Here in New Zealand the Financial Markets Authority has no intention of restricting retail investor access to CoCos, which have been issued by both ASB and Kiwibank so far this year. Both banks issued their notes in minimum denominations of $5,000.


*Dr Martien Lubberink is an Associate Professor in the School of Accounting and Commercial Law at Victoria University. He has worked the the central bank of the Netherlands where he contributed to the development of new regulatory capital standards and regulatory capital disclosure standards for banks worldwide and for banks in Europe (Basel III and CRD IV respectively).

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I love that picture! 


Given that:

  • most investing is via Kiwisaver
  • Most KS schemes are structured as unit trusts
  • Therefore KS savers are oblivious to the underlying instruments which constitute their savings
  • KS schemes will certainly be over the minimum $100K bar

what's to stop KS funds investing in these?


Because their customers sure as sugar won't know.....until it's too late.


Everything you note is correct and was part of the general plan undepinning this type of issuance. All the trades advisors are fully cognisant the paper will find a home in pension plan funds - welcome to the banking industry. But who else is capable or willing to bail banks out? Equally the management staff should be limited to caretaker remuneration packages.


Well I thought there was a reason i keep funds on call. Jesus.


Wouldn't it be awesome to be in a position to put ASB on similiar terms when rocking in for a mortgage - "and yeah by the way, if things start looking bad with my cash flow, i'm just gunna write off my debt to ya, and sorry, no recourse buddy'. On that note, wonder if they have a branch in California?