Contingent Convertible bond is the debt, which is convertible into equity if and when the issuer reaches a specified level of financial distress. CoCo is defined with two elements – the trigger and the conversion rate. While, conversion rate is the actual rate at which debt is swapped for equity, trigger is the pre-specified event causing the conversion (usually this event regards company’s solvency and creditworthiness). This trigger should be specified in a way ensuring automatic, inevitable and inviolable conversion. Also CoCo contract can impose a dynamic sequence in which specified amounts of bonds convert at deferent thresholds of distressed event.
The conversion recapitalizes the issuers without requiring any ex-post actions to raise new equity or the government to bail them out. Thus, CoCos offer a reliable and cheap mechanism to avoid expenses that may arise with the threatened bankruptcy.
Moreover, as long as the bond is not converted into common shares, current diluted EPS will not be diluted by CoCos and, due to its debt nature they will constitutes a tax shield, making them more lucrative rather than simple convertible bonds.