The other distinguishing feature is that there is less credit risk associated with cat bonds because they are all collateralised transactions where the collateral is generally invested in high quality securities such as US Treasury bills. Moreover, unlike many traditional bonds, price fluctuations based on non-quantifiable external factors such as strategic decisions taken by company management have a much lower impact.
‘A DIFFERENT FORM OF RISK’
Of course predicting the severity of hurricanes and earthquakes is a challenge which might help explain why some participants are looking at innovative ways to adopt cat bonds to mitigate other non-climate related risks. For example, last year Amtrak became the first US long distance passenger train company to come to the market with a three-year $275m issuance of cat bonds against wind, earthquakes and storms similar to Hurricane Sandy in 2012 which caused over $1bn in damage.
The bonds which mature in 2018, were issued through a Bermuda-based special purpose entity called PennUnion Re and offer a yield that is 4.5 percentage points higher than the benchmark. They were a hit with investors and the deal was oversubscribed.
The same cannot be said though for the five-year SFr220m Credit Suisse cat bond deal that made its debut in May. The notes did not cover any weather-related events but instead losses between SFr3.5bn and SFr4.2bn from operational failure which ranged from unauthorised trading to computer system disruptions, fraudulent transactions and failures in regulatory compliance.
The Swiss-based bank has come under fire for the nearly $1bn of write-downs on certain market positions after chief executive Tidjane Thiam said he and other senior bank officials were unaware of the size of the positions taken in its global markets division.
Institutional investors were not that enthusiastic and reports were that the size of deal had been whittled down to SFr220m from the original target of up to SFr630m. Alarm bells were rung by a report from HSBC analysts which said triggering the instruments could have systemic effects on the banking system. “It is difficult to separate ‘ordinary’ losses from those from internal control or business processes failures, making the trigger conditions less transparent,” the analysts wrote.
