In the struggle to identify how to avoid a repeat of last year's financial crisis there is an emerging consensus among regulators, academics and practitioners that contingent convertible (Coco) bonds are the way to go. The idea is to have some debt in the capital structure of banks that converts into equity when a bank faces financial distress.

These bonds have some benefits. If, in an extreme downturn, the conversion were triggered, debt-holders would be forced to absorb some losses without dragging other obligations (derivatives or repurchase agreement contracts, for instance) into a bankruptcy process, an event that could trigger a systemic panic. This would save taxpayers large amounts and create incentives for creditors to monitor the issuers, instead of lending freely under the assumption that the government would bail them out.

This approach also has serious shortcomings. A much discussed problem is the conversion trigger. If based on accounting numbers, it might not be activated when it ought to be. The trigger of less than 5 per cent Tier 1 capital, which was set in the first Coco bond issue – by Lloyds Banking Group in November – would not have been activated even at the peak of the crisis. If, instead, the trigger is activated when equity prices are low, the manager could deliberately talk down the bank's value to activate the trigger and obtain equity on the cheap.