Hong Kong has seen two catastrophe bonds issued in less than six months, a noticeable uptick for a small market, as market participants say the city needs to raise investor awareness, offer more incentives to issuers and investors and relax listing rules to support development.
Peak Reinsurance sold its second deal, the US$50m Black Kite Re, at the end of April, marking the seventh deal in the city since the product debuted in 2021 and bringing the total volume to US$798m.
Peak Re's trade, covering Japanese earthquakes and typhoons, as well as Chinese and Indian earthquakes, is the first to include Indian risk.
Peak Re's US$150m issue in 2022 covered Japanese typhoons.
“The cat bond serves as a risk and capital management tool. It diversifies our retrocessions in respect of products and capacity usage,” said Sascha Bruns, head of global retrocession at Peak Re. Retrocession is when a reinsurer transfers part of its risk to another reinsurer.
The April trade was the second Hong Kong deal in less than six months after Taiping Reinsurance sold a US$35m cat bond via special purpose insurer Silk Road Re in December covering earthquake risk in mainland China and windstorm risk in the US.
The market may be picking up steam as more deals are expected. Angus Sip, a partner in the banking and finance group of King & Wood Mallesons, said the law firm is discussing potential insurance-linked securities deals with Chinese insurers.
“They have incentive to do this type of deal, which offers a good alternative to the traditional reinsurance contracts, and Hong Kong has a very strong capital market and financial infrastructure to foster growth of the Asian ILS market. For PRC insurers, it’s a good market to tap into,” said Sip.
Deal volume is likely to remain relatively low in the near future, however, as the instrument faces competition from traditional reinsurance and retrocession products and sidecars, a common structure in the US in which reinsurance vehicles are set up by a sponsoring insurer with a third-party investor.
“This issuance is our first step to include [insurance-linked securities] into our reinsurance strategy to enhance our catastrophe risk management. Whether we’ll sell more will depend on our retrocession needs and the cost of cat bonds. We’ll also consider other ILS products like sidecars,” said Yu Xiaodong, CEO of Taiping Re.
Funds dedicated to catastrophe bonds and ILS have seen rapid growth in the past few years. For insurance and reinsurance companies, cat bonds are an alternative form of risk management with multi-year coverage compared to traditional reinsurance or retrocession products with terms and pricing renewed annually. For investors, they offer diversification with low correlation to traditional asset classes.
Hong Kong's potential
Hong Kong aims to become the Asian hub of the ILS market. The government set up a legislative framework in 2020 for firms to establish special purpose insurers allowing them to issue ILS and launched an issuance grant scheme in 2021.
The scheme, which covers up to 100% or HK$12m (US$1.5m) of upfront costs, was initially a two-year programme that was extended by two years in 2023 and by another three years this year.
It has proven attractive, forming part of Taiping Re and Peak Re’s considerations for the timing of their deals. Peak Re said the outstanding cat bond’s maturity in June and contract renewals were also factors.
Singapore is also trying to attract cat bond business and has its own ILS grant scheme. In July, Lim Cheng Khai, executive director in the financial markets development department of the Monetary Authority of Singapore, said the scheme had supported 28 cat bond issues over five years totalling US$4.4bn.
Sip from KWM said Hong Kong is on the right track, but it is challenging to win over business from Bermuda, a sophisticated market that dominates the ILS space.
“The Hong Kong government has already done a good job attracting family offices, I think they could also consider providing incentives to attract ILS funds, by providing tax benefits, reducing operational cost, offering more sweeteners and streamlining rules for setting up ILS funds in Hong Kong,” he said.
The investor base in Asia is limited. Iain Reynolds, head of third-party capital at Peak Re, said he has not seen much more interest in the past few years. For Peak Re’s deals, most investors are from North America and Europe and include dedicated ILS funds, asset managers, pension funds and insurers and reinsurers.
“I think perhaps we need to do more work as an industry to work on awareness of this asset class among investors in this part of the world,” said Reynolds.
Yu from Taiping Re said another area that Hong Kong could try is allowing cat bond listings, which could support liquidity especially for privately placed bonds. Most of those deals, sold by SPIs, do not meet the net asset requirements. Fifteen cat bonds have listed in Singapore.
Yu also said there are limited financial and legal resources in Hong Kong for ILS issues. To qualify for Hong Kong’s grant scheme, companies need to appoint locally registered service providers.
Aon Securities, GC Securities and Swiss Capital Solution are the only three bookrunners available, and market participants said the city lacks SPI managers, and more are in Singapore.
More broadly, there is a lack of tested reliable industry loss indices in Asia ex-Japan. Cat bond investors lose part or all of their principal amount when a trigger event occurs, and the most commonly used triggers are industry loss and parametric. An industry-loss trigger, which is based on index estimates of total industry losses on the insured event, better matches the loss a reinsurer experiences, while a parametric trigger's payout is a pre-defined amount based on terms that may not cover the actual loss of the reinsurer.
“For the reinsurers, particularly in China mainland, which is where we want to see this market taking off, reliable indices would be a huge step forward in terms of promoting the catastrophe bond industry to support issuance from China. That would be a game changer,” said Reynolds.
Peak Re structured the deal so Chinese and Indian earthquake components are based on a parametric trigger, and Japanese earthquakes and typhoons are based on an industry loss trigger.
“In China and India, we haven't seen very large catastrophe losses from earthquake events yet, and so these indices that report industry loss haven't yet been tested. We would rather see whether they work before we wanted to utilise them,” said Reynolds.