Concocting Marketable Cocos

Adding contingently convertible debt securities, cocos, in an amount equal to about 3% of tangible assets to the financing mix of financial institutions is a promising reform idea. It would also be inexpensive for these institutions to issue cocos and thus to be prepared to recapitalize and to avert failure by rebuilding common equity and reducing leverage and debt overhang in a crisis. For cocos to become readily marketable, much work is needed on their standardization and optimal design. That basic design should include a trigger couched in a regulatory capital ratio referenced in Basel III. It should also include conversion terms setting the rate of increase in the number of shares equal to the rate of growth of the book value of common equity through conversion. This would prevent redistribution from existing to new shareholders, guarantee their equality of treatment, and protect the subordination hierarchy with non-cocos debt.