opinions about the appropriate choices. For institution-level trigger events, there seems to be a
mutual preference of using a rule-based event. Contingent capital instruments with a rule-based
trigger event are perceived to be more transparent, predictable, and attractive to potential investors.
It is also easier to price.
Acharya et al. (2009) think that an industry-level trigger must be rule-based, rather than at the
discretion of regulators. With a discretionary feature, the occurrence of trigger would convey severe
adverse news to the market, causing a possible downward spiral. In contrast, a rule-based trigger
would be well-anticipated and would not have such consequences. In addition, the political pressure
on the regulators for the announcement of conversion is not trivial due to its signaling effect. Squam
Lake Working Group (2009) has a different opinion for the rule-based industry-level trigger: they are
concerned that the aggregate data regulators might use are likely to be imprecise, subject to
revisions, and measured with time lags.
Rating agencies require an objective and rule-based trigger event as one of the preconditions for
assigning a credit rating. Therefore, a rule-based trigger event is more promising from the
perspective of the marketability of contingent capital instruments.
The capital access bond (CAB) proposed by Bolton and Samama (2011) is an exception for
institution-level trigger event. The issuer has the option to convert the CAB into equity at the prespecified
price and also has the full discretion on the conversion. Technically speaking, the
conversion is still based on rules. The conversion will happen if the option is in the money at
maturity. However, as pointed out by the designers, the signaling effects might prevent a decision
based solely on the payoff of the option. Not converting the CAB when the conversion price is less
than current market price of the stock could be conceived by the market as a higher equity value,
which has a positive impact. Or the bank's rational management will be questioned, which has a
negative impact.
3.2 Trigger Event: Institution Level and/or Industry Level
Existing proposals of contingent capital have a conversion trigger based on the issuer's financial
condition and/or on an industry-wide indicator. The issuer's financial conditions can be indicated by
its stock price, capital adequacy ratio, or book value of equity. Industry-wide indicators include
aggregated market loss indices and financial industry loss indices. There is no mutual agreement on
the type of trigger events to be used among the academic and the industry. Up till now, most
existing contingent capital deals are based on an institution-level trigger.
An institution-level trigger event has a focus on the financial condition of the issuer. It is not
opinions about the appropriate choices. For institution-level trigger events, there seems to be amutual preference of using a rule-based event. Contingent capital instruments with a rule-basedtrigger event are perceived to be more transparent, predictable, and attractive to potential investors.It is also easier to price.Acharya et al. (2009) think that an industry-level trigger must be rule-based, rather than at thediscretion of regulators. With a discretionary feature, the occurrence of trigger would convey severeadverse news to the market, causing a possible downward spiral. In contrast, a rule-based triggerwould be well-anticipated and would not have such consequences. In addition, the political pressureon the regulators for the announcement of conversion is not trivial due to its signaling effect. SquamLake Working Group (2009) has a different opinion for the rule-based industry-level trigger: they areconcerned that the aggregate data regulators might use are likely to be imprecise, subject torevisions, and measured with time lags.Rating agencies require an objective and rule-based trigger event as one of the preconditions forassigning a credit rating. Therefore, a rule-based trigger event is more promising from theperspective of the marketability of contingent capital instruments.The capital access bond (CAB) proposed by Bolton and Samama (2011) is an exception forinstitution-level trigger event. The issuer has the option to convert the CAB into equity at the prespecifiedprice and also has the full discretion on the conversion. Technically speaking, the
conversion is still based on rules. The conversion will happen if the option is in the money at
maturity. However, as pointed out by the designers, the signaling effects might prevent a decision
based solely on the payoff of the option. Not converting the CAB when the conversion price is less
than current market price of the stock could be conceived by the market as a higher equity value,
which has a positive impact. Or the bank's rational management will be questioned, which has a
negative impact.
3.2 Trigger Event: Institution Level and/or Industry Level
Existing proposals of contingent capital have a conversion trigger based on the issuer's financial
condition and/or on an industry-wide indicator. The issuer's financial conditions can be indicated by
its stock price, capital adequacy ratio, or book value of equity. Industry-wide indicators include
aggregated market loss indices and financial industry loss indices. There is no mutual agreement on
the type of trigger events to be used among the academic and the industry. Up till now, most
existing contingent capital deals are based on an institution-level trigger.
An institution-level trigger event has a focus on the financial condition of the issuer. It is not
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