The battle of Cocos. Swiss authorities made a mistake with consequences and potentially a host of court cases. They wiped out $17 billion of Additional Tier 1 bonds ( or Contingent Convertible Bonds or Cocos).These were invented after the 2008 crisis to shore up banks’ capital 1/

Cocos are perpetual bonds (traded in the market though) that can be wiped out if the capital of a bank comes below a certain percentage around 6%. They earn a higher interest while alive and that was the incentive to get an easy capital equivalent tool without voting rights. 2/

Bank regulation (Basel III) accepted Cocos or AT1 as part of Tier 1 bank capital, as good as equity for loss absorbing. AT1 should be called-in only after equity was wiped out and the bank capital comes below the percentage mentioned in the AT1 bonds contract 3/

The Swiss authorities didn’t respect that sequence. Formally, equity was not wiped out to absorb losses, it was sold at a price well below market value. The shareholders lost money only because of that low price which is not a reason to bail-in the Cocos. 4/

There will court cases. The market for AT1 is about $250 billion and prices are now going down. There is the concern that the tool may have been destroyed. The ECB, EBA and the SRB issued a statement saying that the Swiss treatment will never happen in the EU. To be followed.. 5/

Markets are still digesting the weekend events and are showing mistrust about bank shares. Both European and US banks stock indices are going slightly down. It is now all about confidence and that means a lot of uncertainty, despite the strong banks situation. 6/

The big issue now is what CBs will do with interest rate policy. The ECB went ahead with a 50bps hike, despite the connection stated in its new Monetary Strategy between monetary policy and financial stability (slide). The FED will decide this Wednesday: nothing or only 25? 7/7