Which cat bond collateral solution?


The debate over what instrument catastrophe bonds should use as a source of collateral going forwards is raging. There’s an interesting article here on Insurance Journal discussing this issue (but sadly not offering any solution). This feels like an issue which is not going to be solved by a one size fits all replacement for the total return swap counterparty. Rather it feels like an issue which may have numerous solutions which are applicable to different size and structures of cat bonds, thus giving the issuers a range of options to work with.

Investors seem happier since a number of deals issued this year chose to utilise highly rated assets such as World Bank issued debt and U.S. money market funds. However, both of those still bring the question of correlation with the financial markets to mind. There have also been discussions about governments providing a swap counterparty service but that is really with regards to government issued bonds.

A panacea hasn’t yet come to light for this issue. The holy grail of a non-correlated collateral source seems a long way off and for now issuers will have to work with what they have and innovate through the use of tight controls and reporting mechanisms to keep investors happy. The solution that is required will no doubt fall out of some research papers over the next few years (as did many innovations in the market in the 1990’s).

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