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The CoCos, those 250,000 million dollar bonds that keep the global financial system in abeyance

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CoCos, short for Convertible Quotas, is the name by which AT1 (Additional Tier 1) bonds are commonly known.

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They are essentially a credit instrument and their particularity is their power of disguise in actions. Some of them are currently circulating in the global financial market. two hundred and fifty billion dollars.

They have acquired a great public resonance since that March 19 in which, as it began to get dark in Bern, after a frantic succession of pressures and concessions, a financial giant, UBS, has gobbled up its main competitor and staunch rival, CS (Credit Suisse), in a gigantic way, of similar specific weight in the banking sector.

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The celebration took place under the auspices and official invitation of the Government of the Swiss Confederation, its National Bank and the Financial Market Supervisory Authority.

It happened during that evening. An extraordinary sleight of hand by the regulatory agency, Finma, with just one dexterous magical pass, disappeared a $17,000,000,000 basket of CoCos, emulating the genius of the incomparable illusionist David Copperfield, who amazed all the public of his time by making even the Statue of Liberty itself disappear.

The surprising direct and immediate economic effect of what happened that night fell upon him investors unaware of those bonds, which have not been converted into shares but into nothing.

A man with the legend stating

A man with the legend stating “a criminal liquidation of Credit Suisse” during the April 4 shareholder meeting.

in the market was very badly perceived and the reaction was the increase in the prices of credit default swaps (CDS)even by banks in good financial health.

The enterprise, the work of a state body with an administrative rather than a legal vocation, had a strong impact on the issuing bodies, who considered it compromised due to their general ability to finance themselves.

Subsequent requests in search of an explanation or information on what was done and on its factual and juridical motivation to reveal the underlying truth of what happened in that cryptic and so-called negotiation were stamped against a closed denial. As is typical of magic and conjuring, but the fact, far from being a work of fiction, had been real.

Furthermore, it happened and had an impact at the least favorable time for the global financial system. They have blown, and persist, hurricane-force winds regardless of geography: inflation, recession and possible stagflation; environmental disasters; high social conflict; diverse and active war scenarios; threats and nuclear readiness and, more recently, the panic sparked by the uncontrollable development of Artificial Intelligence.

Economic history will remember this past March – a month no less fateful than the one two years ago in which Covid alarmed us, and the following one which surprised us with the invasion of Ukraine – because in the current it triggered a crisis of the economy of strong credit.

The 10th began with the violent fall, in the USA, of a systemically important bank, Silicon Valley Bank (SVB), and of Signature Bank, in the same month.

The crisis of the former was triggered by a simple and elementary story. The bank had invested most of depositors’ money in mortgage-backed long-term Treasury bills and bonds, and as technology companies and major customers began withdrawing their deposits, as short-term rates rose more than long-term returns, the price of the bonds in which it was invested plummeted.

Axel Lehmann, Chief Executive Officer of Credit Suisse

Axel Lehmann, Chief Executive Officer of Credit Suisse

The bank was forced to sell at a lossa loss so great that he was kept on artificial life thanks to prompt state intervention, but only hours later all his assets would be gobbled up by First Citizens Bank.

The contagion of illiquidity and/or insolvency in the banking and business world is inevitable and its crises occur from time to time. They spread rapidly, the most compromised institutions being the least solid or lacking state guarantees.

At the height of the crisis that was afflicting the Silicon Valley Bank, the regional and community banks, which support local industries and the variegated business fabric that surrounds them, injured and inert, saw their deposits collapse: in the first week after the major banks and funds were made of one hundred and twenty billion dollars.

It’s normal; Frightened depositors are rapidly migrating to larger institutions that are perceived to be safer, in order to safeguard their savings and investments. Those with FDIC backing are especially sought after there. (Federal Deposit Insurance Corporation) whose funds, sufficient for the moment, are difficult to reach in the midst of a much greater crisis, which will force them to resort to the tired habit of continuing to print paper money.

In Europe the banks of the European Union and the ECB are not in better shape, despite having a stricter regulatory standards than the United States., and includes all financial institutions. An example of what has been said is what happens in Germany with another systemic institution, the Deutsche Bank, which forced the State, without wasting time, to declare through its highest authorities, the commitment to assist in its rescue to avoid bankruptcy; again imposed by the famous too big to fail (too big to fall).

And it is not a unique case: perhaps it will be forced to do the same with Commerzbank, of considerable importance, given that its alarms have sounded in unison with the first ones.

Faced with such a global landscape, the trigger for a highly questionable event like the one that occurred with Credit Suisse’s AT1 bonds has reawakened, with the thaumaturgical effect of eliminating a sidereal liability the appetite of large law firms, passionate about class action lawsuits and eager to discover niches and litigation opportunities.

It is clear that it is more than risky to predict whether or not luck will accompany them, even if it seems that the defense of the rights of the holders, investors or savers punished in the CoCos has solid arguments. The state has acted discretionary, on the basis of a law enacted immediately before the fact, of dubious legality and constitutionalityTherefore, the existing laws and ordinances, the international principles applicable to banking crises and bankruptcies established at the 2010 G20 summit in Washington, are knowingly ignored or marginalized.

The essence of these bonds is their ductility and that contingency and feasibility events are activated, triggering a trigger that converts them into equity if the issuer’s capital has fallen below a certain level or if it requires to be reinstated with state aid.

In the specific circumstances mentioned or in any others foreseen and explained in the Information Prospectus, the amount that the bondholders have delivered to the issuing bank as a loan is transformed into capital. That is, they become the entity’s own funds and retain the corresponding value.

It is also clear that the purchaser of these securities is a strategic investor who knows and takes risk of his type. Presumably, he must have also carried out an adequate economic evaluation and have come to the conclusion that the fee – the interest to be received – is above that current on the market and is convenient for him.

Another consideration that must be kept in mind is that, in the event of bank insolvency, the losers will not primarily be the holders of these securities.

It should be noted that, in this case, although the trigger was activated due to illiquidity – since it was claimed by official and public means that it was solvent – the conversion into shares did not take place. This is because the bonds would have been cancelled, annihilated, producing an absolute and total loss of value for investors.

and that’s not all

Interested CoCo holders have created justifiable resentment against shareholders, per the unequal treatment with which they have been privileged. Indeed, the latter received, without any legal basis, three billion dollars, while at the same time the bondholders were plundered.

Even the market has considered it an injustice and a bad example, and has pitted different categories of interests or groups, bondholders against shareholders; shareholders versus directors; employees versus officials.

Those who should have been the real losers in the event of insolvency or liquidity of a banking institution are not the bondholders but the holders of the share capital.

An employee offers chocolate to shareholders during the April 4 shareholders' meeting.

An employee offers chocolate to shareholders during the April 4 shareholders’ meeting.

The injustice is manifest and the reason can be traced back to the fact that faced with the financial suffocation of Credit Suisse Bank, they preferred go to the administrative path, which implies a conscious departure from pre-established legal norms.

They have not wanted, been able or thought it convenient to implement emergency laws, respect essential juridical principles or resort to judicial appeals. The inevitable invocation of urgency allowed once again to shift what was important and justify applying an ad hoc methodology and forcing a compromise.

It is only an appearance that the situation was resolved through a match between the two colossal contenders; There was no contractual autonomy of the parties or their shareholders.

The merger reached by conventional means was the effect of the State’s commitment to take charge of a huge bill, the items of which include direct contributions, (doubtably) reimbursable credits and guarantees, for the staggering sum of two hundred and thirty-five billion francs swiss.

The price was so high that, to dispel any suspicion of a possible imitation, other international habitués publicly declared that they would not do it, convinced that what happened had compromised the stability of the banking system and undermined confidence in it.

Lesson and questions.

Is the amplified absorbing entity itself capable of greater efficiency in service?

Have state regulatory bodies done their own self-criticism and feel they have the appropriate qualifications and experience?

Have the internal control bodies, and in particular the compliance officers, been efficient in taking care of the legality of the procedures?

Have measures been envisaged for the recovery of the huge salaries and bonuses paid to directors and officers for alleged profits obtained in risky financial bets?

HE Investigate who the real bondholders are? Is there a check on market operators?

It has the general social, human and economic damage that entails the drastic and consequent reduction of jobs, which would only be achieved in the case of UBS 35,000 people between office workers, civil servants and professionals, with the consequent family repercussions?

Perhaps finding an answer to these questions and many others will be a sanatorium.

It is neither harmless nor neutral to consolidate cash-strapped or insolvent financial entities, facilitating their absorption by another with the help of public funds. For something they are given the name of an extinct species of animals from the elephant family.

The baby mammoths are already marching.

Source: Clarin

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