Hong Kong: Protection gaps, Chinese municipalities a key focus for ILS ambitions

After its government expressed its desire to attract more insurance-linked securities (ILS) sponsors to the Hong Kong Special Administrative Region, highlighting a commitment to develop its ILS market, executives from the Insurance Authority have made filling protection gaps a key focus of its ILS ambition.

This will include not just attracting international insurance and reinsurance issuers of catastrophe bonds, but more importantly developing the capital market disaster risk transfer facilities for local insurers and reinsurers, as well as for municipalities in China.

Hong Kong has always had a desire to introduce and integrate ILS risk financing for the belt and road initiative and Greater Bay region.

But, it’s ambitions extend further, towards helping Chinese municipal governments to access the capital markets for disaster risk financing.

It’s roughly 15 years since Artemis began writing about the need for ILS and catastrophe bonds to support Chinese provincial risk pooling efforts, as it became clear municipalities and regions were assuming most of the natural disaster risk and so little was being effectively transferred to international insurance risk markets.

This remains a huge opportunity and one that Hong Kong is now aiming to target its ILS market infrastructure towards.

In an interview with the South China Morning Post, Clement Cheung Wan-ching, CEO of the Insurance Authority (IA) said that there is a selective approach to developing the Hong Kong ILS market.

“We are not just about boosting issuances – we’re talking about whether we can build a system,” he told the newspaper.

“Our first mission is not to talk about the hub,” he said. “The first mission is aiming at resolving this huge protection gap on natural catastrophes, which exists around the world [and], in particular, in this region and China,” he added.

He explained that “Hong Kong can do a lot to fill this gap”, with its insurance market and capital market infrastructures coming together to work on making the ILS offering well-suited to this protection gap goal.

He said that the IA is in discussions with a range of issuers, including the Chinese municipalities.

For years now, it’s been known that municipal, provincial and state finances have been the last-resort insurer of disaster and weather risk in China.

Each year, funding has been put to work in supporting industries like agriculture, but with no backstop of insurance markets, so the funding has tended to be depleted and disbursed after almost every growing season due largely to severe weather events.

Which has made it clear for getting on for two decades, that the ILS market could be a source of risk capital, but also importantly a means for China to diversify its weather and disaster risk outside of its own borders.

Cheung of the IA also noted the importance of data and how a lack of this has held back the ability to transfer risks.

The IA wants to, alongside its financial and risk markets, develop more climate data within the Greater Bay Area and Asia as a whole, while also developing risk modelling capabilities at universities in Hong Kong.

“The question is whether we discover the risks and make sure that the risks can be accumulated, packaged and put into an ILS,” Cheung explained. “That’s where the ecosystem will work.”

He added, “I believe we are going to have issuances every year from now on. We set our KPIs so that we should have regular issuances, but we have to work on more sponsors, different issuers and product types.”

At a recently convened event in Hong Kong to bring together regional insurance-linked securities (ILS) stakeholders and local investors, Stephen Yiu, Chairman of the Insurance Authority (IA) of Hong Kong commented, “Climate change and financial volatilities have sharpened the focus on ILS as an attractive asset class from both the yield and diversification perspectives,” saying that practitioners should “take full advantage of the friendly and efficient environment for ILS issuance forged in Hong Kong.”

Joseph Chan, Acting Secretary for Financial Services and the Treasury, said, “Hong Kong is home to an array of insurers and reinsurers with rich experience and expertise, providing a solid bedrock for our ILS ecosystem to develop. Combined with our connectivity with the Mainland and the rest of world, Hong Kong is an ideal platform for ILS issuance.” He added, “We are striving to have more ILS issuances in Hong Kong, thereby further consolidating Hong Kong’s advantage as an international insurance hub.”

Also participating at the event, Jorge Familiar, Vice President and Treasurer of the World Bank commented, “We look forward to continued collaboration and innovation in the ILS market. Together, we can build a more resilient future for vulnerable nations around the world.”

There is a significant opportunity for Hong Kong’s financial market and it could extend beyond catastrophe bonds, as risk transfer to the capital markets in derivative formats would also be a welcome instrument to the Chinese economy and its participants.

It would be even more encouraging to see the focus broaden, to one of facilitating effective and efficient access to disaster risk financing, in whatever form or structure, or from whatever capital source, rather than purely a narrower focus on cat bonds.