Swiss Re Insurance-Linked Fund Management

Original Risk: A Society for Change Agents

Pending regulation threatens increased cost and complexity for cat bond issuance


Earlier today we announced the publication of a Q3 2011 insurance-linked securities market report from Willis Capital Markets & Advisory, the mergers & acquisitions and capital market products division of global broker Willis Group. There were some interesting points in the report worthy of further discussion including some insight into pending regulatory changes which could affect the catastrophe bond market.

The report discusses two pending U.S. regulatory initiatives which Willis says could pose a ‘theoretical’ threat to catastrophe bond structures.

The first regulatory initiative is proposed ‘no conflicts’ legislation which makes up part of Dodd-Frank (Rule 127B, Section 621 to be precise. This proposed rule addresses issues which occurred during the much discussed Abacus CDO trade where it was alleged that an investment bank issued a deal with the primary purpose of allowing their client to benefit from a loss of principal on the underlying bonds. Rule 127B seeks to ban conflicts of interest between arrangers, sponsors and investors in asset backed securities transactions.

Willis points out that cat bonds have a similar design, they aim to allow the sponsor to recover funds at the same time that an event triggers a reduction in principal. The report says that a common sense approach would exempt cat bonds from this rule but there is a fear that a push for exemption may fail causing inefficiencies and added costs for cat bond issuance.

The second regulatory initiative is proposed changes which come under the Regulation AB laws which look at updating rules for registration, disclosure and reporting for asset backed securities in the U.S. The report from Willis says that this rule again could have the potential to complicate cat bond issuance if an exemption is not granted. They say that it could result in a requirement for risk co-participation as different disclosure requirements.

Willis says that the bottom line for both of these regulatory initiatives is that they have the potential to complicate and increase the costs of cat bond issuance for the second quarter of 2012 and beyond. Willis also suggest that the uncertainty posed by these regulatory changes could result in increased cat bond issuance prior to Q2 2012 as sponsors seek to get transactions to market before new rules come into force.

Regulations have a habit of causing uncertainty, particularly when they apply to a broad spectrum of instruments such as asset backed securities. We suspect that behind the scenes some of the larger players in the cat bond market will be making their feelings heard on these topics to the regulatory powers that be.

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