U.K. Regulator Blocks CoCo Sales to Individual Investors

The U.K.’s Financial Conduct Authority will ban firms from selling contingent convertible bonds to individual investors, saying they’re too complex and risky for the mass retail market.

From Oct. 1, the FCA will limit sales of CoCos to institutional, professional investors and high-net-worth individuals for 12 months, the London-based regulator said in a statement today. The FCA will publish a consultation paper on a set of permanent set of rules for CoCos in September.

“In a low interest rate environment, many investors might be tempted by CoCos offering high headline returns,” Christopher Woolard, the FCA’s director of policy, risk and research, said in a statement today. “However, they are complex and can be highly risky.”

Under pressure from regulators to boost capital after the financial crisis of 2008, banks have been selling CoCos, a form of fixed-income security that automatically converts into ordinary shares if a firm’s capital falls below a pre-determined level. European regulators last month expressed concern banks may be selling them to consumers without properly explaining the risks. Portugal’s bailout of Banco Espirito Santo SA this week left shareholders and junior bondholders with losses.

Embarrassed Regulators?

“Every time a bank gets into trouble and you have retail investors in subordinated debt or CoCos, it gets difficult and embarrassing for the regulators,” said Mark Taber, who helped organize a group of individual holders of Co-Operative Bank Plc bonds when the British lender was restructured following a capital shortfall. “They don’t want to have that problem every time that happens. They want to be able to deal with banks.”

Demand for CoCos has climbed as investors seek higher-yielding assets amid record low interest rates in Europe. Yields on the bonds average 5.87 percent, compared with an average 2.59 percent for corporate debt globally, according to Bank of America Merrill Lynch indexes.

Lenders including Societe Generale SA and Coventry Building Society sold about $39 billion of the securities this year, bringing the total debt outstanding to almost $50 billion, according to data compiled by Bloomberg.

“I don’t believe many retail investors have bought CoCos as the minimum denominations are too high,” said Robert Montague, a senior credit analyst at ECM Asset Management Ltd. in London. “Some dollar CoCos were initially aimed at the Asian private banking market, but we are talking about high net worth individuals.”

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