In May last year Martin Taylor, the former chief executive of Barclays Bank, addressed a crowd of high-powered financiers in the ballroom of the InterContinental Park Lane hotel in London.
Mr Taylor, an adviser to the Bank of England’s Financial Policy Committee and an influential voice on market risk, spoke darkly about his fears for Coco bonds, a quirky-sounding debt instrument launched in the wake of the financial crisis.
“I talk to a group like this about credit matters with the greatest timidity. I am sure you are good citizens and desire to exercise exemplary scrutiny. But I wonder whether you will flip – like the holders of European sovereign bonds before 2010 – from believing all issuers equally safe to thinking many equally precarious when the sky next darkens,” he said.
Skies have not only darkened this week, but Mr Taylor’s words have a prophetic rings: investors have indeed flipped out with concern about Cocos after the German lender Deutsche Bank was forced to reassure investors it could meet interest, or coupon, payments on its Coco bonds.
The move has stoked fears that something is rotten at the heart of the European banking sector and led many to question why Cocos – considered a silver bullet solution – have melted like their chocolate breakfast cereal namesake in the face of market turmoil.
Cocos, formally known as contingent convertible bonds, were born out of the 2008 financial crisis as a solution for stricken banks without the need for a state bail-out.
They work quite simply on the surface: banks issue them to finance their business like normal bonds but they morph into equity if a bank’s capital falls below a certain threshold. This automatically reduces a bank’s debt and boosts its capital buffers at a time when external investors could be reluctant to inject new money.
The flexibility removes some of the risk inherent in loading up bank balance sheets with debt. But herein lies the rub: how can a bank be flexible on debt obligations without spooking the market into thinking it is in trouble?
A recent move by the European Central Bank to publish an obscure test of bank risk, known as the Srep ratio, has driven the recent upset in the market. The results have stoked fears in the minds of credit analysts about whether recent market shocks – ranging from low oil prices to the slowdown in China – could inadvertently cause banks to breach rules which would prompt regulators to stop them paying Coco coupons.
Many lenders – such as Spain’s Banco Popular Espanol, Italy’s UniCredit, BNP Paribas of France and Deutsche Bank – are now getting perilously close to falling into the zone, according to Hermes, posing questions about how far banks will go to protect their Coco coupon payments.
“All these banks still have some strings they can pull,” Hermes’ credit strategist Filippo Alloatti said. “The fundamentals are still the same; this is a test for the Coco market and the incentives for the banks to pay these coupons, if they can, are still there.”
Cocos have grown rapidly since launching in 2009, attracting credit investors keen for high-yielding bonds in a world of low base rates.
Last year was a high-water mark, with banks issuing $175bn worth of Cocos – dwarfing $50bn in 2013 and $14bn in 2009, according to Moody’s.
Yet fears over the Greek debt crisis and the slump in China put a chink in the armour. Issuance slowed to around $77bn last year and this year looks worse, with predictions of $35bn worth of bonds now looking highly optimistic in light of recent events.
Just two Coco issues have come to market this year, according to the data provider CreditSights – from Crédit Agricole and Intesa Sanpaolo.
Many say the Coco market is now effectively closed for the rest of the year unless policymakers simplify the rules and kick-start issues back into life.
“The regulator has made a mistake in the way they are designed,” credit manager Lloyd Harris from Old Mutual Global Investors said. “The regulations are far too draconian in Europe and will have to change. It is potentially difficult for the market to come back to the extent it needs to unless some changes are made.”
One solution could be adopting a US version of Cocos, which are considered less complex than their EU counterparts. If a bank reaches the point of going bust in the US, the Coco is simply bailed in and losses are borne by the bondholder.
In contrast, EU regulators have over-egged the cake by adding additional layers of complexity about how and when banks can pay bondholders. “We should not forget these have been designed by regulators for regulators,” said Gildas Surry, an analyst and partner at credit investor Axiom Alternative Investments. “At some stage, the ECB and the Bank of England will have to defend the format.”
Business picture of the day
Business picture of the day
1/29 UK car production slumps by nearly a fifth in April as timing of Easter bites - Thursday May 24
UK car manufacturing plummeted by almost a fifth in April, as the timing of Easter ate into the number of production days in the month.
2/29 Marks and Spencer reports slump in profit hurt by clothing sales and cost of new food stores - Wednesday 24 May
High street stalwart Marks and Spencer has reported a more than 60 per cent fall in pre-tax profit in the year to the end of March, hurt by a decline in clothing sales and higher costs from opening new food stores. Pre-tax profit came in at £176.4m for the year, while sales were broadly steady at £10.6bn. Food revenue was up 4.2 per cent.
3/29 Apple named world’s most value company in tech-dominated Forbes ranking - Tuesday 23 May
Tech behemoth Apple has been named the most valuable brand in the world for a seventh consecutive year. The highly-regarded ranking, compiled by Forbes magazine, puts the iPhone makers’ brand value at $170bn, a 10 per cent increase on figure for 2016 and well ahead of second-placed Google, whose brand value has risen $19.3bn from last year to just under $102bn, according to Forbes. Tech peer Microsoft nabbed third spot, with a value of $87bn, followed by Facebook at $73.5bn. Consumer goods giant Coca-Cola rounds out the top five with a value of $56.4bn.
4/29 Diamond ring bought for £10 at car boot sale expected to fetch £350,000 at auction - Monday 22 May
A large, diamond ring is expected to fetch £350,000 at auction 30 years after its owner paid £10 for it at a car boot sale, thinking it was a costume jewel. The “exceptionally-sized” stone was presumed not to be real because 19th Century diamonds were not cut to show off their brilliance like today's gems. And so the owner, unaware of its value, wore it for decades, while doing everything from the shopping to the chores.
5/29 $110 Basquiat sold by Family who bought it for $19,000 - Friday 19 May
Jean-Michel Basquiat’s painting of a skull sold for $110.5 million at Sotheby’s in New York, setting an auction record for American artists and providing a windfall for the daughter of two collectors who purchased it for $19,000 in 1984.
6/29 Peppa Pig owner Entertainment One announces 117 new episodes - Friday 19 May
The company that owns the Peppa Pig brand has announced that it is producing 117 new episodes for the popular children’s cartoon. The new series will air from spring 2019 and take the total number of Peppa Pig episodes to 381.
7/29 Property tycoon who banned 'coloured people because of curry smells' faces legal action - Thursday 18 May
A buy-to-let tycoon who banned “coloured people” from his properties “because of curry smells” is facing legal action brought by the equality watchdog. Millionaire Fergus Wilson, who reportedly owns close to 1,000 properties in Kent, sent an email to a local letting agency informing them of the ban. Commission chief executive, Rebecca Hilsenrath, said: “We have asked the court if it agrees with us that Mr Wilson’s lettings policy contains unlawful criteria and, if so, to issue an injunction. “As this is now formal legal action we will release further information at a later date.”
8/29 Nestlé foiled by Cadbury as it loses bid to trademark KitKat bar - Wednesday 17 May
KitKat-maker Nestlé has been foiled again, after a UK Court of Appeal ruled that the consumer goods giant cannot trademark the shape of its popular four-fingered chocolate bar. The ruling is the latest in a long running legal battle between the Swiss-based company and its rival Cadbury. Nestlé argues that the KitKat’s shape is “iconic” and should be protected by law but Cadbury objects. On Wednesday, the Court of Appeal ruled in favour of Cadbury, dismissing the claim.
9/29 Yorkshire is the best region in the UK for workplace happiness - Tuesday 16 May
The best region in Britain for workplace happiness and satisfaction is Yorkshire and the Humber, according to new research. London only managed to make it to number five for happiness and came bottom for work satisfaction, according to research commissioned by recruitment agency Robert Half. The findings may give pause for thought to many workers in the capital putting up with sky-high property prices in the hope of landing their dream job.
10/29 Andy Murray funds company behind world's first foldable bike helmet - Monday May 15
He may be almost unbeatable on the tennis court, but how will Andy Murray fare in the world of investing? On Monday, a company that claims to make the world's first folding bike helmet announced that the tennis pro was one of more than 400 individuals who had helped it raise nearly £700,000 on crowdfunding platform Seedrs. Morpher’s bike helmets fold and unfold, meaning that they can easily be slipped into a bag when not in use, catering to cyclists who find normal helmets cumbersome to carry around.
11/29 Morrisons will sell 'wonky avocados' for just 39p from Monday as demand hit record levels - Friday May 12
Morrisons will start selling deformed avocados at a third of the average cost of normally-shaped ones as growing demand and reduced harvests from major producers has pushed up prices in recent weeks. The supermarket said on Friday that it would start selling the misshapen and superficially blemished fruits for 39p each or £2.40 a kilogramme in the majority of its stores across the UK starting from 15 May until the end of the summer. Morrisons claims that its offer is the cheapest on the UK market and compares to an average retail price of £1.05 apiece, which is up from 98p last year.
12/29 Unilever develops technology to prevent billions of plastic sachets from entering into oceans - Thuesday 11 May
Unilever, the consumer goods giant behind brands such as Dove, Ben & Jerry’s and Marmite, is making a big push toward more sustainable packaging. The company sells billions of products in single-use sachets each year, including cosmetics and food products, particularly in developing and emerging markets. It says that it has now developed new technology to recycle them, which will prevent packaging from ending up in our oceans or in landfill. Through a system called CreaSolv Process, the plastic from the sachets will be recovered and then used to create new ones for Unilever products – creating a full circular economy approach.
13/29 Euro hits a six-month high after Emmanuel Macron’s French presidential victory - Monday 8 May
The euro hit a six-month high against the dollar on Monday and US stock futures briefly touched a record high after Emmanuel Macron won the French presidential election, easily beating anti-EU rival Marine le Pen.
14/29 Princess Charlotte's John Lewis cardigan from birthday photo sells out - Tuesday 2 May
A knitted yellow John Lewis cardigan adorned with pictures of sheep has sold out after Princess Charlotte was photographed wearing the item, prompting a surge in demand from British parents wanting to dress their offspring like the young royal. John Lewis confirmed that the clothing item sold out online shortly after the photograph was published, although a coordinating prink dress, selling for £10 on the John Lewis’ website, was still available on Tuesday morning.
HRH The Duchess of Cambridge via Getty Images
15/29 Dubai becomes first city in world with own Microsoft font - Monday 1 May
Dubai has become the first city in the world to get its own front, the government announced on Sunday. The type face, simply called “Dubai Font”, comes in both Arabic and Latin script and will be available in 23 languages. It was created in partnership with Microsoft and is now available to Microsoft Office 365 users around the world.
16/29 Donald Trump administration loses trade battle over tuna as WTO lets Mexico hit US with sanctions - Wednesday April 26
The US has just lost a major trade battle with Mexico and it revolved around tuna. On Tuesday, the World Trade Organisation ruled that Mexico is allowed to impose $163m (£127m) a year in sanctions against the US on trade in tuna, ending a years-long dispute. The clash, which dates back to 2008, centred on the US insisting that any Mexican tuna sold in the US must have a ‘dolphin safe’ guarantee, meaning that no dolphins were killed by fishermen catching the tuna.
17/29 Luxury brand LVMH to snap up Christian Dior for £10bn - Tuesday 25 April
French billionaire Bernard Arnault moved to consolidate control over Christian Dior for about €12.1bn (£10.3bn), folding the fashion house’s operations into the LVMH luxury empire in one of his biggest transactions.
18/29 Euro and shares rally after Emmanuel Macron wins first voting round of French election - Monday 24 April
The euro briefly surged to a five-month high against a basket of currencies late Sunday after centrist candidate Emmanuel Macron won the first round of a hotly contested French election vote, an outcome broadly considered the most market-friendly. Immediately after the vote, the euro surged to $1.0940, its highest level against the dollar since November last year, before retreating to around $1.0869.
19/29 Barbie out of fashion as Mattel slumps - Friday 21 April
Mattel shares took a hit after the world’s largest toy company reported a much worse than expected sales slump dragged down by poor demand for key brands such as Barbie and Fisher-Price. Shares in the company dropped 6 per cent to $23.70 (£18.50) in after-hours trading in New York on Thursday after the toymaker reported a loss of $133.2m or 33 cents per share for the three months to 31 March. Barbie sales, which begun to recover last year after the toymaker introduced new dolls with different body types and skin colours, slipped again with gross sales down 13 per cent compared to a year ago - their second consecutive quarter of decline.
20/29 Government to sell Green Investment Bank to Macquarie in £2.3bn deal - Thursday 20 April
The British Government said on Thursday it would sell Green Investment Bank to a consortium led by Macquarie Bank in a deal worth £2.3bn. The British Government set up GIB, which backs green projects with public funds, in 2012 as a commercial venture to spur private investment in green projects. It has invested more than £2bn in projects such as offshore wind farms and waste management. The Government decided to sell a majority stake in 2015, saying it would give the bank more freedom to borrow, remove state aid restrictions and allow it to attract more capital.
AFP/ Getty Images
21/29 Snap election threatens Government plan to finally lower energy bills - Wednesday 19 April
Energy customers face further delays from government in dealing with with soaring bills, MPs heard on Wednesday. Business secretary Greg Clark accused companies of “flagrant mistreatment” and “milking” their customers in a “broken” market, but insisted the snap general election announced by Theresa May on Tuesday meant he would “have to reflect on the timing” to lay out his long-awaited plans for a crackdown.
22/29 Pound sterling surges as Theresa May calls for 8 June general election - Tuesday 18 April
The pound surged against the dollar on Tuesday to its highest level since last December after Prime Minister Theresa May said she wanted a general election on 8 June. When Ms May announced she wanted a new national poll, at around 11.05am, the pound instantly jumped, climbing to $1.2765 by the end of trading, up 1.62 per cent on the day and the highest since 13 December. It was also sterling's biggest one day jump since March 2016.
23/29 China's first quarter growth beats expectations - Monday 17 April
This aerial photo taken on April 12, 2017 shows farmers working in the fields in Yangzhou, in eastern China's Jiangsu province. ina's growth stabilised in the first quarter thanks to rising investments and a recovery in exports. cording to an AFP survey of 16 economic analysts, the gross domestic product expanded 6.8 percent in the first three months of this year
24/29 Rome’s Trevi Fountain generates €1.4m for city’s charities in 2016 - Thursday April 13
Rome’s Trevi Fountain was a veritable cash cow for the Eternal city’s charities in 2016, according to new data. The charity Caritas said this week that tourists tossed €1.4m (£1.2m) into the baroque fountain last year, helping to subsidise a supermarket for Rome’s needy
Andreas Solaro/AFP/Getty Images
25/29 Pret and Paul offer discount to customers who bring their own coffee cup - Monday April 10
French bakery group Paul and sandwich chain Pret a Manger will begin offering discounts to customers bringing in their own reusable cups, yielding to pressure from environmental groups concerned about the mountains of cardboard waste generated in the UK each year.
26/29 Doritos, Coco Pops, Peperami among latest products to be hit by shrinkflation - Thursday April 6
Bags of Doritos, packets Peperami and boxes Coco Pops have become the latest treats to shrink in size as retailers passed on surging costs from the Brexit-hit pound and rising commodity prices.
27/29 Cuban family making their own wine brand using condoms - Wednesday April 5
family wine business in Cuba is thriving thanks in part to an unconventional item being added into the fermentation process – condoms. As a result of the US trade embargo and other inefficiencies of Cuba's economy, thousands of basic household items are inaccessible to Cubans meaning that sometimes a little creativity is required to get the job done. At El Canal, a winery in Havana, Orestes Estevez and his family fill glass jugs with grapes, ginger and hibiscus, before securing a condom over each glass jug Allowing Heathrow to expand will create “a serious obstacle” to meeting the UK’s commitments on climate change and reducing air pollution, a leading scientist has warned.
28/29 'Pink Star' diamond sells for world record £57m in Hong Kong auction - Tuesday April 4
A rare pink diamond dubbed the “Pink Star” has become the world's most expensive gemstone to sell at auction, coming under the hammer in Hong Kong on Tuesday for $71.2m (£57.3m). The oval-cut 59.6 carat jewel, discovered in a mine in Africa by De Beers in 1999, is the largest fancy vivid pink diamond, categorised as “flawless” or “internally flawless”, that the Gemological Institute of America (GIA) has ever graded. It sold after a five-minute bidding war, that started at $56m, to Hong Kong jewellery retailer Chow Tai Fook at Sotheby's.
29/29 Stopping climate change could boost the world economy by £15 trillion - Tuesday March 21
Efforts to slow climate change won’t just keep the planet habitable. They will also boost the world economy by $19 trillion (£15.2 trillion). Investments in renewable power and energy efficiency will add about 0.8 per cent to global gross domestic product by 2050, the International Renewable Energy Agency, or Irena, said Monday in a report produced for the German government. Governments are committing resources to green energy in a bid to keep warming within 2 degrees Celsius (3.6 Fahrenheit), of pre-industrial conditions, in accordance with the landmark Paris Agreement on global warming.
He added that it would difficult for Europe to adopt a US model because it is now “less mature” than the European model.
“The level of regulation and supervision in Europe is now extreme,” he said.
Martin Taylor has been both a banker and a market quasi-regulator. Perhaps it’s time the authorities starting listening more to the former and less to the latter.
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