Investment banking group Credit Suisse has turned to the insurance-linked securities (ILS) market as it looks to secure a source of capital market investor backed, fully-collateralised insurance and reinsurance protection to cover its operational risks.
We understand that Credit Suisse is in the early stages of marketing and assessing investor interest for what it terms an ILS bond linked to operational risk. Essentially it seems to be a catastrophe bond type structure, which would transfer a certain amount of Credit Suisse’s operational risk exposure to the bond’s investors.
The deal would have a five-year term and be structured on an annual aggregate and indemnity trigger basis, people familiar with the mooted transaction said. Credit Suisse is said to have turned to the ILS market as traditional reinsurance capacity was not available (or perhaps keenly priced enough) to back the transfer of its operational risks.
In order to effect the deal, sources said that Credit Suisse plans to enter into an insurance arrangement with Zurich Insurance Group. This would involve a five-year insurance policy covering CHF 700m (approximately $690m) of the investment banks operational risks.
If the ILS deal goes ahead, Zurich will retain 10% of the operational risks while the rest would be transferred in a quota share reinsurance deal to a Bermuda domiciled SPI, which would in turn be the issuing vehicle for the operational risk linked ILS notes.
So that would make the ILS deal, or operational risk catastrophe bond, a CHF 630m transaction (around $620m), which is a large issuance and would likely need broad investor support.
However, such a bond may have appeal outside the ILS investor base, providing Credit Suisse with a much greater potential list of subscribers, enabling it to get what seems a large and innovative transaction to market.
The ILS or catastrophe bond structure, with its securitised, trigger based approach to coverage, does seem ideal for covering this type of risk. Operational risks for large investment banks are broad and varied, but with an indemnity trigger and annual aggregate coverage, the ILS bond could respond very closely tied to the underlying insurance policy, we’d imagine.
We’re told the bond would be triggered when Credit Suisse suffered over CHF 3.5 billion of losses under the operational risk insurance agreement in any annual risk period (the attachment point), with an exhaustion point set at CHF 4.2 billion.
Sources said the deal is cleverly structured such that it cannot be triggered by a single loss event, and so requiring a build up of operational risk impacts to the investment bank before investors could lose any principal.
If the operational risk ILS is successfully brought to market it will be a first, perhaps paving the way for repeat transactions from other issuers. It would be another demonstration of the broadening of the ILS market and that the ILS and cat bond structure is eminently suitable for a wider range of risks than are currently transferred in the ILS market.
We’re told investors would receive a 4% of notional coupon for their investment and that the notes, if issued, would have an expected loss of 0.15%. That makes the operational risk ILS deal fairly remote in terms of risk, but the key will be in helping investors to understand that.
This is not the type of risk that investors in ILS are used to and it could take some time to increase their comfort to a level where they are keen to invest. But it is an interesting and unique investment opportunity in the ILS sector, providing a potentially useful portfolio addition and diversifier.
We understand that Credit Suisse has itself structured and designed the securitisation for this operational risk ILS or catastrophe bond and that it would also act as placement agent or bookrunner for the deal.
It’s good to see some further innovation in the ILS market, with Credit Suisse seeking to leverage the ILS structure to provide itself with a source of insurance for its operational risks. There has always been an expectation that eventually people will find new risks that are suitable for ILS risk transfer, this could be a very promising development for the broadening of the market.
We’ll update you should any further details become available.
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