Japanese primary insurance group Tokio Marine & Nichido Fire Insurance Co. Ltd. is to redeem its most recent catastrophe bond, the yen denominated JPY 35 billion, approximately $290m, Kizuna Re II Ltd. (Series 2015-1).
The four-year term Japanese earthquake cat bond was the first to see its collateral assets invested in a Japanese Yen denominated investment fund and that fund is now to be liquidated. Which raises the possibility of this being due to the recent shift to negative interest rates at the central bank of Japan or to potential tax obligations or costs in moving to another permitted investment fund.
The notes are being redeemed under an early redemption event number VI. Standard & Poor’s describes this as permitting:
“The cedent to terminate the reinsurance agreement and redeem the deal early if it believes the supplemental premium payments (the annual service provider expenses) or a fee charged or imposed on any cash credit balance in the JPY deposit account or collateral account is likely (in TMNF’s sole discretion) to exceed $750,000 in a risk period or $2 million during the term of the transaction.”
According to rating agency Standard & Poor’s the collateral fund, the JPMorgan JPY Cash Liquidity Fund, is to be liquidated by its manager JPMorgan Asset Management on the 11th March 2016 and proceeds from that fund, including the collateral from this cat bond, will be disbursed to investors on 14th March.
The funds in the Kizuna Re II 2015’s cat bond collateral account will be held in cash during the period between liquidation and disbursement, S&P explained.
The Kizuna Re II cat bond transaction featured six possible redemption event options, and the fact that the sponsor has elected to do so under this particular redemption clause is due to the collateral account and this fund liquidation, with the negative Japanese interest rate one possible cause.
S&P explained that this particular redemption event has no early redemption payment associated with it, so the sponsor, Tokio Marine & Nichido Fire Insurance Co. Ltd., will not need to compensate investors in the Kizuna Re II notes for the termination of the deal, they will simply receive their principal back.
So it’s possible that the fund is being liquidated due to an inability to meet investment return targets due to the negative interest rate situation in Japan, with this affecting the cat bond. Or there could have been cost or tax implications associated with the liquidation and moving to another fund.
Whether it would have then cost the issuer more than the amount the redemption clause states, to reinvest into an alternative fund, we cannot be sure. However it is probably that the type of stable, treasury or equivalent, type of Japanese Yen denominated investment that cat bond collateral is typically invested in would be difficult to maintain in a negative interest rate environment.
S&P said that it expects that the issuer will pay all interest due, as well as the principal to note holders on the redemption date, which is likely to be the 1st April 2016.
No rating actions are currently warranted, S&P continued, as this redemption was not viewed as material to the ratings of the Kizuna Re II 2015 cat bond and the issue was not reviewed by rating committee.
Note, we cannot be certain that the negative interest rate situation in Japan was the ultimate cause of this cat bond termination, but it could be one factor in the decision.