What the instrument is
A contingent convertible bond, widely known by the market shorthand "CoCo", is a subordinated debt instrument designed to absorb losses while the issuing bank is still a going concern. In the European framework these instruments are generally structured to qualify as additional tier 1 capital. They combine features of debt and equity: they pay a coupon like a bond, but carry a built-in mechanism that converts them into common equity or writes down their principal when the bank's capital falls to a pre-defined level.
The defining feature is the automatic loss-absorption trigger. To count as AT1, an instrument must convert to CET1 or be written down when the issuer's common equity tier 1 ratio drops to a level set in the terms, which under the CRR may be no lower than 5.125%. Issuers commonly set higher triggers. Because the trigger operates mechanically on a capital ratio rather than requiring the bank to have failed, the instrument absorbs losses during ordinary operation, which is what makes it going-concern capital rather than a purely resolution instrument.
How it works in practice
AT1 CoCos are perpetual, with no fixed maturity, and are callable only with supervisory permission. Their coupons are fully discretionary and non-cumulative: the bank can cancel them without triggering default, and coupon payment is further constrained when the combined buffer requirement is breached, through the maximum distributable amount. These features ensure the instrument behaves like loss-absorbing capital, not senior debt, before any conversion occurs.
Two additional loss channels sit beyond the contractual trigger. Even if the CET1 trigger is not breached, AT1 instruments are exposed to the statutory write-down and conversion powers at the point of non-viability, and to bail-in in resolution. An AT1 holder can therefore face loss either through the instrument's own mechanical trigger while the bank operates, or through the authorities' powers once viability is in question.
Legal basis
Contingent convertible bonds that qualify as AT1 are governed by the additional tier 1 provisions of the CRR, Articles 51 and 52, which set the eligibility conditions, including the mandatory conversion or write-down mechanism and the trigger at a CET1 ratio no lower than 5.125%. Their treatment at the point of non-viability and in resolution follows from the write-down and conversion powers in the BRRD, Articles 59 to 62.
Practical relevance for banks and investors
For banks, AT1 CoCos are an efficient way to build going-concern capacity above CET1 while retaining an instrument with debt-like tax and coupon features. For investors, they offer higher yield in exchange for layered risks that are distinctive to the class: coupon cancellation, extension beyond expected call dates, mechanical conversion or write-down on a capital trigger, and full exposure to write-down at the point of non-viability. Understanding the specific trigger level and loss mechanism in each instrument's terms is essential to pricing it.