Dr John Seo (pictured), Co-Founder and Managing Principal, Fermat Capital Management on the UK government’s plans for tax legislation allowing cat bonds to be issued from and domiciled in the UK…
2014 was a record year for cat bond issuance, coming in at USD 8.4 billion. This positive trend has shown no sign of abating as we progress into 2015. Issuance for the year through to mid-April is predicted to be up 27% on 2014, at approximately USD 2.1 billion, with the full-year trend looking just as positive. Indeed, on 5 April we saw seven new issues released to market simultaneously. We believe this is a first.
The recently improved supply/demand balance has been beneficial for the market. We are now seeing bonds trading at a discount to their original issue price – something last seen back in September 2012. The increase in issuance has returned the power of choice to investors. An increase or decrease of only 0.25% in offered yield has been enough to take several new cat bond deals this year from 3x over-subscribed to a near or complete failure to launch – a remarkable price discipline considering the general lack of high yielding bonds in traditional bond markets. As a result, cat bond yields have improved for the first time since 2012.
Providing a clear signal of the increasing importance of cat bonds to global insurance markets, the UK government recently announced as part of its budget plans to craft tax legislation to allow cat bonds to be issued from and domiciled in the UK. Such a change would lower the cost of bringing cat bonds to market, accelerate growth of the market, and help create even more favourable conditions for cat bond investors.
Taking lessons from 2012, first-quarter issuance surges do not necessarily result in strong early year returns. But this should not be taken as a leading indicator for the year as a whole. Quarterly returns are hard to call in this market, due to the impact of flows, but for the full year the relatively short-dated nature of the bonds makes things more predictable. Any change in market behaviour takes time to trickle through to performance, so it is essential to look at full-year returns, being encouraged by the events during the opening months of the year.
While cat bond spreads were higher in 2012 than they are now, lessons from the past still apply. We expect to see a similar performance pattern this year to that of 2012. Assuming no major loss events, market conditions could deliver 4-5% to cat bond investors this year.
