As the collateralised reinsurance market continues to expand at a faster rate than the insurance-linked securities (ILS) sector, it appears to be contributing to the declining transparency of the alternative reinsurance markets, warns Lane Financial.
In all financial markets of the world, tension between transparency and opaqueness exists, says Lane Financial. While some industry participants support and promote greater transparency on pricing, trading, and all aspects of a marketplace, others seek to keep markets as opaque as possible, in the hope of gaining an edge.
“It has been our experience that notwithstanding TRACE the price transparency of the ILS market has been declining. Fewer “pricing sheets” are being generated and some of the ones that are produced quote quite wide markets,” says Lane Financial, in an ILS industry note.
TRACE is the FINRA compliance engine, and enables anyone to see the price at which an ILS transaction, such as a catastrophe bond, traded in the secondary market, which does promote liquidity and transparency.
According to Lane Financial the “more and tighter” pricing available the better this is for market transparency and more detailed analysis, which in turn should result in increased investor and sponsor comfort and confidence in the asset class, ultimately helping its continued expansion into new peril regions.
And, “it’s not just ILS that concerns us,” says Lane Financial, “ILW prices provide another useful insight into the current market but while once widely distributed are increasingly rare and less reliable.”
One element of the expanding, international ILS sector that could be contributing to a decline in market transparency, concerns growth in the collateralised reinsurance (CR) markets, says Lane Financial.
While beneficial, as it offers investors with a broader and more robust set of exposures, the collateralised reinsurance market is growing at a much faster rate than the ILS market, which, owing to its lack of transparency could be part of the transparency issue within the marketplace, explains Lane Financial.
“CR is to a dark pool as ILS is to a lit exchange. If the ILS market is now 30% of the combined alternative market and the CR market is priced off the visible ILS market it should send up warning flags,” says Lane Financial.
To give some context, Lane Financial explains that a ‘dark pool’ is an alternative market system that effectively operates in the dark, so offering less transparency in the hope their dark status enables them to move larger orders discreetly, so without moving the broader marketplace.
In contrast, “lit” market exchanges are fully open and transparent in terms of all trading and pricing, in real-time.
“Further executed prices on, say, the NYSE must be at least as good as the National Best Bid or National Best Offer from all other licensed exchanges. The consolidated tape of the National Best Bid and Offer from all exchanges is known as the NBBO,” explains Lane Financial.
“Nothing in principal wrong with that except that as the dark pools get larger the lit market NBBO prices get derived from a smaller and smaller share of the market. Thinner markets can more easily be manipulated and the public market prices become less and less representative of what is really going on,” the firm continued to explain.
Regarding the ILS and collateralised reinsurance markets, Lane Financial explains that investment/hedge funds provide Net Asset Valuations (NAV) with given frequency to enable exiting and incoming shareholders with a fair exit or entry point into the secondary marketplace.
However, “the more that is based on a smaller and smaller ILS market the less credible is the overall valuation,” says Lane Financial.
While the catastrophe bond market itself has never been completely transparent, according to Lane Financial valuable market transparency is declining, which could be in part due to continued growth of the opaque collateralised reinsurance market.
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