Investors show huge interest in data centre risk. Diversification story of ILS a consideration: SIFMA

During the SIFMA ILS conference in Miami yesterday a panel discussed the topic of data centre risk and some of the considerations that need to be kept in mind as the insurance-linked securities (ILS) market looks at these potentially meaningful opportunities.

With the global data centre build-out continuing at pace and investments into their construction and financing growing, thoughts in the insurance and reinsurance market are on the enormous capacity opportunity to cover the significant risk limits being discussed, with ILS instruments seen likely to play a role, given the depths of capital market funds that could be deployed to support these facilities.

Dinesh Pawar, Head of Insurance Debt at specialist ILS manager Twelve Securis brought the investor perspective to the discussion and highlighted the potential appetite that could be tapped into from the investor base, but also cautioned that the overall non-correlation and diversification story of ILS investments may not always hold, depending on the structures utilised.

Pawar stated, “It’s a complex subject matter, but I think, when we speak to our end-investor base, there’s a huge amount of interest in terms of this type of risk.”

However, education is going to be critical as a new risk opportunity comes to the ILS market and Pawar highlighted that, “The kind of questions we’re being asked is, how are you looking at data centre risk, are you looking at cyber? You know, the end investor seems to be bundling these two types of risks together.”

He continued, “The reality of it is there’s huge demand. Even when you look at it from a portfolio context, and you have the traditional, say, cat bond portfolio, which can have quake risk, hurricane, etc, introducing this type of new peril makes a huge amount of sense from a portfolio construction perspective, and investors are looking for that at the moment.

“If you think about all the problems which are happening around broader financial markets and when correlations at the moment are one, when rates are selling off equities are selling off, it’s unheard of. So investors are looking for this new type of risk, and whether you can introduce it into your portfolios.”

There are other considerations, on the portfolio side, Pawar explained, “The amount of work that’s required to assess this type of risk, there’s a huge amount of things that one would have to consider when they’re looking at modelling this type of risk. From a traditional portfolio perspective, if you’ve got your models and your systems and your processes set up to look at US hurricane or earthquake risk, then you have to diversify into maybe what could be just one line item in your portfolio. From a portfolio construction perspective, is it really worth it?”

He went on to say, “From our perspective, it’s early days. It requires a broad amount of thinking in terms of, look are we going to put the amount of effort into looking at these type of risk if the deal flow is not going to come on a regular basis?

“So first of all, we want to see an established process and established market coming through, that there’s a whole line of instruments coming along.

“But I can definitely see our end-investor group who are looking at this and saying, this could be very, very interesting from a portfolio perspective, for diversification and everything.”

Pawar then explained that at Twelve Securis the firm is discussing topics related to data centres such as, what are the metrics that are available around the operators themselves, how are risks clustered and how should that be dealt with, as well as transaction specific items such as attachment points.

“The argument could be attachment points have to be a lot higher, because the value of these things is quite a lot,” he stated.

Business interruption is another potential “big elephant in the room” that the ILS market and its investors will need to both understand and get comfortable with, he further explained.

Correlation and how diversifying these exposures would actually be is another area for focus, not least because a major selling point for ILS is in the inherently diversifying nature of the stream of investment returns.

Pawar explained, “How does an investor like us, who’s got a very systematic process for when a deal comes in, we look at it, we assess it, we run the models, we put it through the systems, and we can quite easily quantify it. All of a sudden, if you introduce something into your portfolio that starts to correlate with what’s going on in the equity markets, or may correlate what’s going on in fixed income IG. You know, some of the big players have been big issuers of debt. So if you have a big system outage where you have a data centre that goes down, not only will the debt come off, but the equity market may trade down, the negative headlines in the press are going to be very bad.

“All of a sudden you’re having to explain to your end-investor, well actually we’ve got a bit of this risk in our portfolios. Then the whole diversification play of non-correlation of ILS goes away.”

Pawar’s comments at the SIFMA ILS conference speak to the prudent and cautious way investment managers in the ILS space are approaching the potential opportunity presented by data centres.

Read other Artemis articles about the data centre risk transfer opportunity for ILS here.