The last year has seen a move towards issuers of catastrophe bonds and insurance-linked securities bringing more ILS deals to market as private transactions, without rating and with less involvement of certain service providers. The idea behind these private ILS and cat bond deals is to reduce the frictional costs of issuance and speed transactions to market, but an interview in the recent Willis Capital Markets & Advisory (WCMA) Q3 ILS market report suggests that private deals may be more expensive than you think.
Now when we talk about expense it doesn’t have to purely mean money. Remember that much of the discussion of private cat bond and ILS transactions has referred to the reduced time to market, lowering of frictional costs and simpler execution. So generally the perception is that private deals have reduced overheads and many market observers have been predicting that more and more issuers will do private deals rather than full Rule 144A transactions because of this.
Included in the Willis ILS market report is an interview with Michael Madigan, a partner with Sidley Austin LLP who has been involved in the cat bond market since its inception. The interview discusses the trend towards private cat bonds and asks Michael for his perspective on the trend and whether he feels the perception that time and money can be saved by transacting ILS privately is a valid one.
He says that he is skeptical about the reasons given for this trend away from the 144A security in ILS. He says that placing a private cat bond or ILS as a Reg 4(2) transaction is not as easy as you might think because you are negotiating the structure and the documentation directly with investors. These investors may have their own law firms involved which he says is not so bad when they are experienced ILS investors, but if not you can imagine the legal overhead that could result from much back and forth over deal terms and documentation issues.
Michael makes a good point here, and this goes some way to explain why many of the recent private cat bond deals have tended to be executed for a small club of investors who are prepped for the transaction in advance and experienced in the sector. This can make execution simpler, particularly if documentation is as standard as possible. Private deals have also tended to be smaller in size meaning that fewer investors are required which can lower the execution overheads.
Another good point Michael raises is regarding secondary market transferability of the cat bond securities. WCMA ask him in the interview about the issue of private transactions often having transferability restrictions and that they can also lack the price discovery required for secondary market trading. Michael says that there are potential issues here as cedents need to be sure that new investors buying the bonds really understand the structure as this could pose a risk to the cedent if the bonds were triggered. A lack of third-parties ensuring the transactions integrity and reviewing the documentation means that a privately placed bond often hasn’t undergone the same scrutiny as a Rule 144A issuance.
If the private cat bonds were made non-transferable, Michael suggests that you could have a regulatory issue as they could be viewed as insurance rather than a security (a security is generally considered something freely tradeable by regulators).
So while private cat bonds and private ILS transactions are an increasing trend there are definitely points to consider and due diligence to be undertaken before issuance to ensure the deals are robust and correctly considered. There is a chance for an increase in overheads and frictional costs in some cases due to the less standardised nature, particularly where many investors are involved. So don’t be fooled into thinking that taking you cat bond or ILS transaction private will automatically save costs. That won’t always be the case and Rule 144A standardisation and regulation is there for a very good reason.
The interview contains some excellent insight from Michael and the report as a whole is a great Q3 overview from Willis. Download the report in PDF format here.