Unusual levels of cat bond trading recorded on TRACE

An interesting burst of catastrophe bond trading has been recorded on the U.S. Financial Industry Regulatory Authority, Inc. (FINRA) Trace Reporting and Compliance Engine (TRACE) this week, with a high volume of trades and a high number of cat bond names changing hands across just two days.

The secondary market for catastrophe bonds is relatively liquid, but trading volume is not really all that high and the number of trades recorded in the TRACE system is often just in single figures per day, with some days seeing no trading action at all.

But this week, over the course of Monday 20th and Tuesday 21st November, the TRACE system has recorded a huge number of trades, compared to normal levels of cat bond trading activity.

It’s always hard to see the true levels of trading, as TRACE records both broker and buyers activity, so sometimes there could be duplicates and also TRACE only records any trades larger than $1 million in size as 1m+, hence we cannot work out the true volume.

But from our analysis it looks as if 44 individual cat bond names traded over the first two days of this week, with some names trading multiple times, resulting in somewhere around 80 to 90 individual trades.

In terms of volumes, we can definitively count almost $34 million of cat bond note volume changing hands, but many of these are recorded as $1m+, so could be much larger. Looking at the TRACE data in a different way suggests the total volume could have been nearer $45 million or more of cat bond note volume traded across these two days.

In a market of around $30 billion of outstanding cat bond and ILS notes which are tradable, this is still a drop in the ocean and in other asset classes this percentage of a market trading in a couple of days would be quite normal.

But in the ILS and catastrophe bond world this is an unusual volume and we’re told that the majority of it involved one ILS fund manager or investor seeking to trade out of many of its catastrophe bond positions, with one source suggesting it was a liquidation of much of a portfolio.

There are numerous reasons why an ILS fund manager or investor might have to sell so many cat bond positions in such a short space of time.

The most obvious ones, given the losses that the ILS and collateralized reinsurance market has faced of late, is to free up capital using its liquid assets, either to replace trapped collateral it cannot put to work at the renewals, or because there is the potential for better rates in private ILS and reinsurance deals than in the older cat bond names.

It’s also possible that an investor may choose to lay off older cat bonds in the hopes that future issues may provide a yield uptick, although this would mean holding capital until the issuance pipeline increased which most fund managers would avoid.

Another reason could be an investor that is simply getting out of catastrophe bonds and chose this week to do so.

The most plausible would seem a sale to free up capital, to replace trapped or to ready for the reinsurance renewal. However we cannot confirm of course.

The TRACE system provides a useful level of transparency in the catastrophe bond market, as before its use was adopted and cat bond trades reported we would have had no visibility of this kind of unusual trading activity.

This transparency is going to get even better in the future, as we explained recently, because all European brokered cat bond trades will soon have to be reported in TRACE as well.

Join us in New York in February 2018 for our next ILS conference