Co-Cos are suppose to automatically convert into equity as a financial institution runs into trouble.
In contrast to his Bank of England colleague David Miles, who has said banks should more than double their capital ratios to 20%, Haldane argued that piling in more capital to banks might not be answer. Instead, he questioned whether the new regime for bank capital – known as Basel III after the Swiss city where the regulators are based – "will be sufficient to cope with next time's crisis".
Basel III is replacing Basel I – the first international standard for bank capital agreed in 1988 – and Basel II, which was implemented before the 2007 financial crisis unfolded.
"There may be straightforward ways to rebalance the Basel scales, re-injecting market discipline," Haldane said. "Having banks issue a graduated set of contingent convertible securities [to the bankers as part of their bonus], which are responsive to early signs of market stress, is one possible way of doing so."A primary reason for having bankers purchase Co-Cos is that with current financial reporting they are the only substantial buyers of Co-Cos. Of all the potential investors, only bankers have access to the current assets and liability-level detail of their financial institution and can therefore assess the risk. No other investor can assess the risk and therefore value these securities.
The FDR Framework suggests a way to make Co-Cos attractive to investors and address the following problems Mr. Haldane identifies with Basel III capital requirements.
A critic might argue that regulatory capital ratios have become too complex to verify, too error-prone to be reliably robust and too leaden-footed to enable prompt corrective action,Under the FDR Framework, the steps needed to make Co-Cos attractive to investors and an important part of a financial institution's capital structure are:
- Require financial institutions to disclose their current assets and liability-level data. Access to this data will allow investors to assess the risk of the financial institution and value the Co-Cos.
- Require financial institutions to issue two types of Co-Cos: one funded by banker bonuses and the second, of equal or greater size, purchased by investors not affiliated with the financial institution.
Investor Co-Cos are the best friend of the regulators responsible for financial institution supervision. Their price is the market's way of telling the regulator that there are issues with a specific institution.