Panic Dynamics
The TLAC literature is surprisingly sparse regarding the susceptibility of TLAC to panics. Persaud (2014) argues that the most likely investors in CoCos would be hedge funds and other investors with short time horizons, who would be likely to run rather than hold for the longer term if a number of banks got into trouble at the same time.
Regulators do not want banks to hold CoCos of other banks, because doing so would increase the likelihood of a systemic problem.Persaud notes that regulators want long-term investors, such as pension funds and life insurance companies, to be the primary holders of these securities but argues that these entities are poorly designed to do so. Given the longer-term nature of their liabilities, their natural hedging advantage lies in holding diversified portfolios of instruments that offer higher returns because they are illiquid. He also observes that it is by no means clear that the outcome in crises would be more equitable if losses were imposed on pensioners holding claims on insurance companies rather than on taxpayers. As for retail investors, Persaud observes that in 2014 UK authorities suspended the sale of CoCos to them on grounds that the instruments were highly complex and inappropriate for the mass retail market. Overall, he characterizes bail-in securities as “fool's gold” that will “bring forward and spread a crisis, not snuff it out” (p. 6).
A hint of possible market panic dynamics from CoCos came in early 2016, when investors became concerned that, following unusual losses in 2015, Deutsche Bank might be forced to miss a coupon on its convertible bonds (in this case, alternative tier 1 bonds subject to contingent writedown). The yield on the bonds in question soared from 6.0 to 13.5 percent, and the bank's stock price fell 40 percent in five weeks. A leading index of CoCo bonds fell from a 2015 high of 104.6 cents to 88.8 cents on the euro in early March 2016, casting doubt on the future viability of the market for these instruments, which at that time had grown to $102 billion.[166] A new round of difficulties for Deutsche Bank arose in September 2016, when the US Department of Justice provisionally imposed a fine of $14 billion on the bank for misleading investors in sales of mortgage-backed securities. Appendix 5A examines the case of Deutsche Bank, primarily as a window into not only potential panic dynamics of TLAC but also differences between European and US banks with respect to market perceptions of the quality of asset book values.