Recent proposals from the U.S. Securities & Exchange Commission (SEC), regarding tightening of money market fund (MMF) regulations, could impact the catastrophe bond and insurance-linked securities market. Most cat bonds, ILS and many collateralized reinsurance transactions utilise money market funds as collateral assets.
The proposals from the SEC, made on the 5th June, suggest that money market fund regulations are amended to allow the net asset value (NAV) of an MMF to move from the standard $1 share price. This could have the effect of reducing the value of the MMF’s held within a cat bond or ILS collateral trust account.
On a cat bond deal, where the collateral is typically invested in MMF, this could mean that the value of the collateral becomes less than the amount of principal the cat bond was originally sold for. That could have two impacts, one potentially lessening the payout were a cat bond to be triggered, although the issuance documentation would we imagine denote the amount paid out, or two, and more likely, reducing the repayment of principal to investors on maturity of the deal.
Rating agency Standard & Poor’s said that if the value of MMF’s that a cat bonds collateral is invested in was reduced it could take a rating action on the cat bond as it may reduce its ability to pay investors their principal back.
This potential money market fund collateral issue would, we imagine, have to be dealt with by the sponsors of a cat bond. In the event that MMF’s reduced in value the sponsor might have to top-up collateral accounts to keep the value equal to the transactions principal amount. Of course, were the value to move the other way and go up then the sponsor might find its cat bond, ILS or collateralized transaction over-collateralized for a time.
It’s not a difficult issue to solve but it is one that catastrophe bond sponsors and users of money market funds within collateralized reinsurance structures should be aware of.
The second reform that the SEC has proposed involves prime institutional MMF’s and would be optional for treasury and government MMF’s. The proposal would allow an MMF funds directors to suspend redemptions, but for no more than 30 days within a 90 day period. S&P said that were this suspension to occur when funds were needed to make a payout on a triggered or defaulted cat bond then it could take a rating action on that issue.
This second issue is again possible to overcome, simply by making the sponsor wait for a payout. However that would negate one of the positive aspects of catastrophe bonds, that they can in many cases payout more promptly than other reinsurance coverages. That said, a 30 day wait is not too long and the market is likely to learn to live with this restriction if the proposal goes through.
Standard & Poor’s RatingsDirect subscribers can find more detail on both proposals in a report from S&P, “Assessing The Impact That Recent U.S. Money Market Fund Reform Proposals Could Have On Principal Stability Fund Ratings,” which was published by the rating agency on 18th June 2013.