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European banking recovery heralds first ‘CoCo’ bond ETF launch

Contingent convertible bondsThe recovery in the European banking sector has prompted WisdomTree to launch an exchange-traded fund (ETF) that invests in hybrid debt securities issued by the region’s banks.

Listed in London, it is the first ETF to access the $170 billion (€144 billion) market in contingent convertible bonds – also known as “CoCo” bonds - related to European banks’ additional tier 1 (AT1) bank debt, WisdomTree says.

CoCos are a form of hybrid debt that can convert into equity or have their principal written down to absorb the issuer’s capital losses in circumstance such as where an issuer falls below a specified liquidity ratio.

According to IHS Markit, which provides the index for the WisdomTree product, the European Commission’s Capital Requirements Directive IV - which implements the EU banking solvency rules known as Basel III - has led to an increase in the issuance of CoCos which are designed to satisfy the loss-absorbing capital requirements of banks.

The WisdomTree AT1 CoCo Bond Ucits ETF means professional investors could earn higher yields than investing in senior bank debt, and “possibly mitigate their fixed income portfolio’s exposure to rising interest rates”, according to the firm.

WisdomTree said the market environment is supportive for AT1 CoCo valuations, partly due to the reinforced capital positions of European banks, and stronger bank balance sheets stemming from the solvency rules.

Further, in a rising interest rate environment the banks could see greater earnings, the firm added.

Rafi Aviav, WisdomTree head of product development in Europe, claimed the launch was a “major development for investors globally” as, for the first time, they can gain diversified exposure in a Ucits structure to the AT1 CoCo market with the “ease and efficiency of trading an ETF”.

“The developed Europe AT1 CoCo market offers attractive yields - currently at 5.1% - and could also potentially serve as a diversifier for bond portfolios in a rising rate environment,” Aviav said.

AT1 CoCos have outperformed European Bank Corporates by 4.3% and European bank equities by 6.4%, WisdomTree said, using Bloomberg data.

The fund tracks the Markit iBoxx Contingent Convertible Liquid Developed Europe AT1 index.

The ETF could be seen as an innovation in the fixed income market, which earlier this week was criticised by a new bond ETF provider, Tabula Investment Management, for a lack of development.

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