Markel CATCo and D.E. Shaw in collateral release dispute

Retrocessional reinsurance focused fund manager Markel CATCo Investment Management and tech focused hedge fund investor with a liking for reinsurance-linked returns D. E. Shaw & Co. are involved in a dispute over a release of collateral related to industry-loss triggered derivative contracts, we have learned.

Publicly available court documents seen by Artemis show that the plaintiff in this case is the in run-off Markel CATCo Reinsurance Fund Ltd., which is the master fund used by Markel CATCo Investment Management, acting on behalf of its Diversified Fund segregated account.

The defendants are a range of D.E. Shaw owned and operated investment fund entities, named as D.E. Shaw Composite Portfolios, LLC, D.E. Shaw Multi-Asset Portfolios, LLC and D.E. Shaw Oculus Portfolios, LLC.

We understand that the complaint boils down to contract language related to an industry-loss trigger and reporting agencies. This case continues, so we won’t be making any comment on its potential outcome here, just reporting the facts of the matter.

Markel CATCo’s complaint is that D.E. Shaw has refused to release collateral back to the retro reinsurance focused investment manager after the related contracts in question had been terminated.

Twelve catastrophe derivative transactions are featured in the complaint, that Markel CATCo had entered into with D.E. Shaw back in 2018.

The terms of the contracts, which appear to be industry-loss warranties (ILW’s), would have seen Markel CATCo making fixed payments to D.E. Shaw, should the industry loss for specified natural disasters have reached above a pre-defined trigger point, as reported by a third party.

The complaint in question is related to 2018’s Japanese typhoon Jebi, one of the largest catastrophe loss events of the year for the insurance and reinsurance industry.

The contracts would have paid out to the benefit of D.E. Shaw had typhoon Jebi’s industry losses reached above a pre-defined trigger point using data reported by reinsurance firm Munich Re’s Nat Cat Service.

Had Munich Re Nat Cat reported the industry loss from typhoon Jebi was equal to or greater than the pre-defined trigger, the contract would have paid out and Markel CATCo would have been required to pay D.E. Shaw a pre-determined amount.

An important fact in the complaint is that the contracts featured a pre-negotiated and agreed extension clause, which would allow for the ILW’s contracts to remain active for a fixed period should an industry loss report fail to be sufficient to trigger the instruments but be high enough to suggest that an update to it might see the contract coverage triggered.

If that clause was satisfied then the ILW’s would remain in-force for a contractually defined period, if not they would terminate and at that point a collateral release would be expected to occur.

With typhoon Jebi, the complaint argues that as of March 30th 2020, which was the official “Extension Determination Date” when it would be decided whether an extension of term was contractually due, or not, losses from the storm were still below the trigger.

An extension would be allowed should two factors both be true, first that further loss reports were possible and second that the most recent loss report cites an industry loss total for the event that is equal to or greater than 70% of the trigger point.

In the case of Munich Re Nat Cat’s latest report on typhoon Jebi, the first is true as the company never officially closes down an industry estimate (as it is not an official reporting agency for transaction purposes, more on this further down), but the second was not true, as the complainant states the latest report on Jebi saw the industry total “significantly less than 70 percent of the Covered Event Threshold for Japan wind-storm.”

As a result the clause related to a potential extension of the disputed contracts was not satisfied, the complainant Markel CATCo states, meaning the contracts terminated on March 31st and a return of collateral was due.

Markel CATCo said that it sent the swap termination notices to the trustee, BNY Mellon, after which the trustee would request consent to the terminations from D.E. Shaw following which the collateral would typically be returned.

But in this case, Markel CATCo is claiming that D.E. Shaw “attempted to resuscitate and extend Markel CATCo’s insurance obligations relating to Typhoon Jebi.”

The complaint states that on April 6th 2020, through reinsurance broker Guy Carpenter, D.E. Shaw requested that the reporting publisher for the contracts (Munich Re Nat Cat) was changed to use PCS instead.

The complaint states that the estimate from this different publisher was higher for typhoon Jebi and that this was “a transparent attempt to retroactively satisfy the Extension Condition for the terminated Swaps by replacing the agreed-upon Report Publisher with a different report publisher that happened to have published a higher loss estimate for Typhoon Jebi.”

As a result, consent to release the collateral was not given by D.E. Shaw, the complaint states, and Markel CATCo asserts that the defendant has no basis to withhold the collateral, given the extension clause was not satisfied and the ILW contracts should be terminated as a result.

As a result, Markel CATCo asserts that it is not obligated to change the reporting agent source of data and sees no reason to do so, so asserting that D.E. Shaw is in breach of the trust agreement and so has appealed to the court to resolve the matter.

We’ll leave it to the court to decide whether the complaint is reasonable and should be upheld.

But it’s worth remembering that industry loss estimate reporting can be a bit of a minefield and the insurance and reinsurance industry is peppered with legal disputes related to this. All of which suggests you should choose your reporting agency well and make sure they have a robust, defensible and well-established methodology.

We’ll update you should we hear anything further on the outcome of this legal complaint.