Coco bonds are different to regular convertible bonds in that the likelihood of the bonds converting to equity is “contingent” on a specified event. They carry a distinct accounting advantage as unlike other kinds of convertible bonds, they do not have to be included in a company’s diluted earnings per share until the bonds are eligible for conversion. It is also a form of capital that regulators hope could help buttress a bank’s finances in times of stress. CoCo bonds have become popular due to their ability to absorb losses and satisfy regulatory requirements. CoCos are hybrid capital securities that absorb losses in accordance with their contractual terms when the capital of the issuing bank falls below a certain level. Then debt is reduced and bank capitalisation gets a boost. Owing to their capacity to absorb losses, CoCos have the potential to satisfy regulatory capital requirements. However, CoCo bonds, like all bonds, are non-Shariah compliant due to their bond features. Possible Shariah compliant structures as an alternative for Islamic banks to absorb losses and meet Basel III requirements are AT1 Sukuk. However, there are challenges in respect to such Sukuk. There is still a debate on which structure to use for this type of Sukuk. Furthermore, the pricing of the conversion is another area which needs further research. Overall, Islamic banks need viable Shariah compliant alternatives to be able to compete, grow and meet regulatory requirements laid down by the Basel accords. Sukuk products currently seem to be the most viable and plausible to deal with capital requirements.
This research paper is authored by Mufti Faraz as a Shariah advisor for Shariyah Review Bureau in Bahrain. Click on the following link to get access to this paper: