ILS industry responds to ESMA call for evidence on cat bonds as UCITS eligible assets

The insurance-linked securities (ILS) industry has come together to respond to the European Securities & Markets Authority (ESMA) call for evidence to support a review of the Undertakings for Collective Investment in Transferable Securities (UCITS) Eligible Assets Directive (EAD), highlighting the reasons catastrophe bonds are beneficial assets for investors and suitable assets for UCITS strategies.

Recall that, ESMA launched its call for evidence on UCITS eligible assets back in May this year, asking for information from stakeholders to assess any possible risk and benefits of UCITS gaining exposure to certain alternative asset classes.

Catastrophe bonds are a relatively small component of the overall UCITS fund assets universe, which by ESMA’s numbers consist of more than €9 trillion of assets under management.

In the catastrophe bond fund space, we track UCITS cat bond fund assets under management in this chart, with the latest total as of the end of June 2024 having reached almost $12.2 billion.

In the ESMA call for evidence, catastrophe bonds were cited as an example of an asset class that the Authority wanted to understand more about.

Questions that ESMA wanted to answer are related to liquidity, risk diversification and the ability of a UCITS fund to ensure it can allow redemptions on request from investors and regularly calculate its net asset value as required, with the concern seemingly being that some assets may not be as suited to its rules as others.

The insurance-linked securities (ILS) industry has come together to respond and we’ve now seen a copy of the response, which is both thoughtful and detailed, explaining the features of the cat bond asset class and why it should be considered well-suited to the UCITS fund structure.

Respondents include many of the leading catastrophe bond and ILS players, with Fermat Capital Management, LLC, Icosa Investments AG, Leadenhall Capital Partners LLP, LGT Capital Partners, Plenum Investments Ltd., Schroder Investment Management (Europe) S.A., Securis Investment Partners LLP, Swiss Re Capital Markets Corporation, and Twelve Capital AG all providing their opinions either as part of a combined ILS industry response, in individual responses, or both of these forms.

In total the responding ILS asset managers account for the vast majority of UCITS cat bond fund assets.

In addition there are responses from financial and fund organisations, as well as other asset managers.

The statements submitted in response to the call for evidence all conclude that catastrophe bonds are a suitable asset for UCITS funds, that the market is very well-regulated, has good transparency and has ample liquidity.

In fact, some responses highlight that catastrophe bond market trading experiences asset turnover of similar levels to major financial exchanges such as the NYSE, under normal circumstances.

The combined ILS industry response highlights 11 key merits of catastrophe bonds, to drive home the opinion that their structural features and the

The 11 merits cited state that catastrophe bonds:

Are fully-funded instruments and a cornerstone of the global re/insurance marketplace.
Highlighting their use as an efficient and effective sources of risk capital and risk transfer in insurance and reinsurance, offering sponsor security and certainty.
Have robust transaction structures and investor protections.
That cat bonds are typically highly structured and come with all the associated due diligence and scrutiny applicable in the 144A market, with investor protections, tradability and a specialist service provider landscape of structurers, arrangers, initial purchases and secondary trading desks.
Highlight the clearing, custody and safekeeping features of the cat bond asset class.
That major banks provide the custodial services to investors and holders, while clearing and settlement follows standard securities market terms and that clearing parties limit credit exposure for market participants.
Qualify as SFDR Article 8 and 9 instruments.
Explains that insurance is a form of social capital by its nature, providing timely capital and liquidity in the event of disasters to improve the overall resilience of societies and economies to natural catastrophes and climate exposures, while also offering a forward-looking indicator of risks.
That cat bonds are risk controlled.
With formal independent quantitative risk analysis from expert firms, backed by advanced science and technology, investors and managers are able to analyse the risk in cat bonds and make informed investment decisions.
That sponsors of cat bonds are highly regulated and supervised.
The majority of cat bond sponsors are regulated insurance and reinsurance companies, as well as governments and large corporations, while since the inclusion of cat bonds in UCITS in 2011, the respondents have not encountered any regulatory or investor issues with cat bonds.
Explain that the cat bond market is diverse.
As a broad market, cat bonds offer diversification across sponsors, perils, geographies, structures, tranches and triggers, which meaning that it is easy for funds to meet UCITS diversification requirements within the cat bond market.
That cat bonds have liquidity and that the market has low volatility.
The respondents all highlight market liquidity, saying it is available and the secondary trading desks provide great utility to investors and fund managers, while it has continued to trade through events and in times of broader financial market issues. At the same time volatility is relatively low and investors are able to trade in and out of cat bond positions without inducing large price movements under a broad range of market environments.
That the features of cat bonds mean that UCITS funds have the ability to satisfy redemptions.
That the cat bond market is able to service investor redemptions in an orderly manner in non-stressed and stressed market conditions, while all respondent UCITS cat bond fund managers say they have been able to satisfy all investor redemption requests in a timely manner.
That cat bonds improve the resilience of developing countries.
The responses highlight the role of catastrophe bonds in enhancing the resilience of sponsors, especially in the case of World Bank IBRD deals that support the disaster risk financing needs of developing countries with relatively low insurance penetration.
And that the performance of cat bonds depend on clearly defined parameters.
Importantly, the respondents highlight that when major events occur there is no information asymmetry between a cat bond buyer and the reinsured in respect of such loss events, these typically being front page news and so known immediately after occurrence. They also note again the simple structure of cat bonds, with clear write-down mechanics and again that volatility is low in the market, but that this is not an indicator for a lack of liquidity.

Importantly, the responses all highlight the professional and specialised nature of the managers of UCITS catastrophe bond funds and that track-records are strong.

It’s also worth highlighting from some other responses that, the way cat bond fund managers report to their investors on a regular basis about performance of strategies, potential loss event activity and also educate them on the market and how it is developing, means this asset class is one of the most transparent in that regard.

The responses are robust, detailed and clearly highlight the suitability of catastrophe bonds and their beneficial features for investors, so provide ESMA with plenty of information to inform its ongoing regulation of the UCITS fund structure and asset class.

The Authority has also received feedback on other types of alternative assets and will now be able to consider these important inputs as it looks to ensure the UCITS structure remains both supportive and protective of investors.

You can find the full responses over on the ESMA website.

Analyse UCITS cat bond fund performance, using the Plenum CAT Bond UCITS Fund Indices.

Analyse UCITS catastrophe bond fund assets under management using this chart.

Analyse catastrophe bond market yields over time.