During results season the impacts and effects of a softened reinsurance market rear their head across the market and brokers are not immune, with Willis Towers Watson reporting that a “dramatic” slowing of capital markets transactions hit a key business units revenue.
We should note that Willis Towers Watson (WTW) is not the first broking group to note the effects of lumpiness in issuance trends for capital markets insurance and reinsurance transactions, such as catastrophe bonds.
Brokers received handsome fees for their work in originating, structuring and distributing capital markets transactions such as catastrophe bonds and hence if there is a change to issuance patterns, or a slowdown in deal-flow, it can impact their results quite heavily.
WTW reports today that its Investment, Risk & Reinsurance segment, which houses the Willis Capital Markets & Advisory (WCMA) unit that deals with insurance-linked securities (ILS) transactions including cat bonds, generated commissions and fees of $292 million in the third-quarter, which is down 9% (5% constant currency decline and 5% organic decline) from the prior year and represents a 5% organic revenue growth decline.
WTW saw growth in revenues in its Wholesale, Risk Consulting and Investment units, but this growth was more than offset “primarily by a decline in Capital Markets, as transactions have slowed dramatically, and there has been softness in the North American Reinsurance market,” the broker explained.
It’s really no surprise, as capital market transaction flow is lumpy indeed and catastrophe bond structuring or bookrunning likely commands the highest fees for the main broker capital markets units, such as WCMA.
Driving this decline and the slight slowdown seen in catastrophe bond issuance in 2016 is the effect of the soft reinsurance market, which continues to drive capital markets transactions towards the less liquid, but more cheaply transacted, collateralised reinsurance or private ILS deals.
As we wrote recently, the current phase of the reinsurance market cycle dictates that illiquid collateralised reinsurance is currently more popular as a form of ILS transaction. This is clearly having an impact on broker revenues.
As we said, WTW is not the first to report this in its results, we’ve heard similar from both Aon and Guy Carpenter before.
It’s a further sign that when rates are low capital markets transactions are pushed towards the often faster to transact and less liquid collateralised offerings, over the full-blown but perhaps preferable to many investors catastrophe bonds.
However, we would say that “dramatic” is perhaps the wrong word when the ILS market, which is based on capital markets transactions, has grown continued to expand over recent quarters.
Hence the number of capital markets or ILS transactions entered into hasn’t declined, just their nature has changed. So it is perhaps the shifting trend towards illiquid transactions that results in reduced fee opportunity for capital markets brokers.
Interestingly, WCMA highlighted this very trend in its latest ILS market report which you can download here.
Of course it is also important to note that WCMA also facilitates many other investment banking and capital markets roles, such as M&A transaction arrangement, capital raising etc. These transactions can also be affected by market conditions, making the capital markets work an area of a broker that is always going to fluctuate at times.