“It Could be You” (but not necessarily in a good way)
Andrew Stafford QC (London) and Jonathan D. Cogan (New York)
Kobre & Kim
“It could be you” is the catch phrase of the UK’s best known lottery game. It may turn out to be applicable to Catastrophe Bonds (“CAT bonds”)unless insurers and investors are sophisticated and wary and have an appetite for pursuing or defending litigation.
CAT bonds are a form of Insurance Linked Security (“ILS”) and play an increasingly important role for insurers hedging against risks they are underwriting. They areessentially an alternative to re-insurance. In the United Kingdom, the Treasury has been encouraging the idea that London should become a hub for the fast-expanding market, currently estimated to be worth US $22 billion. In May 2015, a task force was set up to investigate the establishment of London as a hub to compete with offshore centres such as Bermuda and Cayman. In recent weeks, China reintroduced the first CAT bond covering Chinese earthquake perils. Yields are generallyattractive, modelling implies catastrophic events are rare, and the bonds have so far generated little litigation. This article explores some of the risks CAT bonds carry and what the future might look like.
When catastrophe strikes in the form of, say, an earthquake, flood or hurricane, an insurer faces huge claim demands. Traditionally, the insurer would hedge this by means of re-insurance. CAT bonds offer access to other funding as a means to hedge against the risk. Package a whole series of catastrophe policies and sell derivative bonds paying an attractive yield and you have a CAT bond.
An insurer issues or sponsors the issue of a bond, often through a third party special purpose vehicle (“SPV”). The investor hands over capital (the Principal) to the SPV. The SPV may invest the Principal (usually AAA rated stock) and make regular payments to the investor, sometimes pegged to a market standard, such as LIBOR, during the period of the Bond. Some Bonds may be traded on a secondary market. At maturity, the Principal is returned to the investor – assuming that events have not intervened….
In the event of a catastrophe (in “real world” terms) third parties can determine whether it is a catastrophe for the purposes of the Bond and, if so, what the effect is on the Principal. Some or all of the Principal may be sacrificed to the insurer at the investor’s loss. This may wipe out the SPV’s material reserves, and may wipe out the bonds.
For the insurer, the attraction of issuing CAT bonds is the generation of capital reserves and diversifying risk. Perils spanning different geographies, risk profile and type may be bundled together in a single product. In place of anannually renewable and re-calculated premium, insurers can secure a hedge at a single price over a longer period of time. The bond attracts buyers from beyond the traditional arena of re-insurers – selling bonds gives insurers access to a different source of capital. There is also the perception that moving away from traditional re-insurance also means moving away from the downside of long-standing relationships – the pay-back cycle in which re-insurance premiums rise following an extreme insured event. For the bondholder, there is attraction of an annual return on investment,the likelihood of repayment on maturity, and the capacity to trade the bonds. Moreover, when interest rates are at historic lows, the annual yield on CAT bonds is especially alluring to prospective purchasers.
The success of CAT bonds depends in part upon the sophistication with which insurers calculate the risk of a trigger event and how this then translates into a commercially attractive issue price. It also depends upon the capacity of the prospective buyer to evaluate the risk. There are two features which are worth noting. The first is the modelling which underlies a CAT bond. Insurers run highly complex programmes which enable them to reach a conclusion as to the probability of a trigger event over a particular period of time. Unlike re-insurers which may be well-placed to subject modelling to close scrutiny, an investor from outside the insurance industry may lack the wherewithal to undertake a similar due diligence exercise. Secondly, as with for example mortgage-backed securities, the process of bundling and packaging a series of policies inside the wrapper of a bond renders more opaque the substance of the underlying risk which the investor is buying. Some commentators have expressed the view that CAT bonds will eventually generate a catastrophe of their own as a consequence of these features, a prediction which has itself been denied by some of the architects of bonds.
The consequences of a trigger event include the total wipe-out of the bond, with the loss obviously falling on the bond-holders. In these circumstances, bond-holders have a powerful incentive to find ways to evade this unpleasantness. There are five options will likely present themselves in these circumstances. The first option is litigating the terms of the bond, seeking to establish that the catastrophe falls outside the scope of the contractual trigger, or that the contractual trigger has not been validly pulled. Second, it may be possible to litigate on the basis that the way in which the bond was presented offends relevant prospectus rules. Third, the bond-holder could argue in litigation that the bond has been mis-sold (a variation on the second). Fourth, the bonds could be sold as distressed debt to so-called vulture funds, leaving those with most appetite for litigation to take up the cudgels. Fifth, the bond-holders could also sue third parties which have played a role in the issue and operation of the bond.
These options echo responses to the default or near wipe-out of other securitised debt of recent vintage. CAT bonds themselves have so far been litigated very rarely. One example of CAT bond litigation is the Mariah Re case which was recently before the Second Circuit Court of Appeal in the United States.
Mariah Re Ltd. (“Mariah”) was a SPV established to provide reinsurance to American Family Mutual Insurance Company (“American Family”). ISO Services, Inc. and AIR Worldwide Corporation signed agreements with Mariah obligating them to report on severe weather events and calculate the amount, if any, Mariah would need to pay to American Family. Mariah was wiped out. The contention was that ISO Services, Inc. and AIR Worldwide Corporation had acted in breach of their contracts, as a consequence of which Mariah Re had paid to American Family far more than was contractually due. In addition to suing ISO Services, Inc. and AIR Worldwide Corporation, proceedings were also pursued against American Family on the basis of breaches by it of its reinsurance contract with Mariah Re, and for unjust enrichment. Mariah (by then in liquidation) was used as the vehicle to sue third parties – the external severe weather reporter, the calculation agent, and the insurer which received the pay-out from Mariah.
Mariah is a perfect example of the dynamic inherent to CAT bonds. The wipe-out event incentivised the SPV to litigate. The cost-benefit analysis of litigation was obvious in view of the wipe-out. When weighing up whether to invest in CAT bonds, potential investors will take into account the potential avenues for recourse. Those involved in the issue and operation of bonds (including third party contractors) will note that when a catastrophe strikes, there will be no shelter from being drawn into litigation. With this kind of scenario in mind, it points to one conclusion – stormy weather ahead.
A practical guide to the UCITS KIIDs annual update
By Ulf Herbig at Kneip
We take a practical look at the UCITS KIID
What is a UCITS KIID and what is it used for?
The Key Investor Information Document (KIID) is a 2- or 3-page summary document detailing a fund’s charges, risk & reward profile, past performance and the overall objectives and investment policy.
What does the regulation say about the annual update?
In terms of annual updates, according to EU Regulation 583/2010, Fund Managers have 35 business days (excluding weekends) from December 31 to issue a revised version of the KIIDs including the performance of the calendar year that just ended.
The Regulation says that the documents must not only be produced but also made available to investors before the 35-business-day-delay is elapsed. This means that Fund Managers must compute the past performances for the year 2020, update the documents that are currently made public, in all applicable languages, proceed with filing to regulators and ensure that these documents are published on websites.
When is the deadline this year?
In the absence of any legal holiday in January and February, the deadline is set to 35 business days from January 1st, which leads to Friday 19 February 2021.
If there is a legal holiday between January 1st and February 19th, then the deadline can be extended accordingly to the next business day. However, we always recommend sticking to the deadline without taking any legal holiday in January or February into account.
What can be challenging with the annual update?
The annual update production cycle can be challenging in many areas:
Scope management. Overall, the scope of the annual update must be the first and foremost task to be done, early in January. The annual update must be done on all share classes for which performances for at least on full calendar year (real or simulated) can be shown. This means that share classes launched in 2020, where the Fund Manager does not want to show simulated performances, may be excluded from the scope of the annual update of 2021. The monitoring of the KIIDs for these share classes launched in 2020 shall continue its normal life but will not be affected by an update of performance as long as there is not a full calendar year of performances to be shown.
Computation of 2020 past performance. this is the main task to be done in relation to the annual update and is a mechanical computation of the net performance of the share class or the fund from 31 Dec 2019 to 31 Dec 2020, with an assumption of the dividends paid during the year being reinvested into the fund.
Consideration of inactivity periods during 2020. When the share class of the fund had one or more periods of inactivity during the year, then the following question is to be considered: Do we, as a manufacturer, show either a) no performance for 2020 in the KIID and provide a written explanation instead, or b) show the 2020 performance in the KIID and simulate the performance during the dormancy period based on a benchmark?
Material changes other than past performance to be incorporated in the KIID. Very often the annual update is also a time where other changes may be incorporated, being driven by changes in the regulation or changes triggered by a modification of the prospectus. We would tend to consider the implementation of these changes at the same time as the KIID annual update production, to make sure the filing to home and host regulators is being done once and for all.
Is this year’s annual update any different?
In terms of document production, the processing remains the same as the previous years, even though the year that just ended may have been tough for many organizations and might have impacted the net performance of the funds.
Should you already start to think about the move from KIID to KID?
As of today, the grandfathering for Asset Managers allowing them to produce and issue a UCITS KIID in lieu of a PRIIPs KID will come to an end on Dec 31, 2021. This means that this year should be the last year of having to handle an annual update of the KIIDs and that a PRIIPs KID will have to be produced from Jan 1, 2022. Therefore, the time to start thinking about the move to the PRIIPs is now.
However, there is currently no approved regulatory technical standards (RTS) available at the level of European Supervisory Authorities, which means that product manufacturers do not have any guidelines as to how to produce the PRIIPs KIDs by Jan 1, 2022. We expect to have draft RTS issued by the ESAs by end of January, with a final version to be ratified by the EU Commission one of two months later, as the earliest.
This means that the implementation timeframe, if the deadline is maintained, will be very limited and will put significant pressure on product manufacturers to get this implementation over the line within deadline.
There is also a possibility that a further extension of the grandfathering period is granted, which would extend the use of the UCITS KIID for a longer period. This, if applied, would be a welcomed relief for market participants in the fund managers who are already under huge regulatory pressure.
How to Take Control of Retirement Planning in 2021 and Beyond
What does your dream retirement look like? What kind of lifestyle do you imagine? Maybe you’re planning to travel more, or perhaps you’re thinking of going back to school. Maybe that passion for photography could become a new business, or perhaps you’re simply looking forward to taking a break and enjoy spending more precious time with those you love.
Whether retirement will see you bungee jumping in South Africa, or trampoline jumping with the grandkids, Steve Pennington, Head of Wealth Planning at Private and Commercial Bank Arbuthnot Latham discusses how planning your retirement now will help bring those dreams the chance of becoming reality.
There are so many “what if’s” and unknowns to take into consideration that retirement planning can feel daunting. What kind of retirement lifestyle can you actually expect? What if I want to (or need) retire early? What if I or my partner needs care in older age? What if my children or grandchildren need financial support? What if I want to buy a Jaguar E Type? What if my investments fall?
2020 has only added to these concerns, so what can you do to feel more in control?
Understanding what you want to achieve is the first step. Is the key goal to maintain your lifestyle in retirement, or do you have different priorities? By looking at your cash flow today and modelling a range of anticipated cash flow scenarios in retirement, you can immediately visualise your future financial position. Through building in key personal milestones such as a change in lifestyle, travel, downsizing, buying that car, or selling a business, you can build a clearer of picture of what you’ll need and when.
More than 10 years until retirement
Look at your current later life provisions. How do you intend to use your non pension assets in retirement? How and when do you actually intend to use your pensions? Are you planning to stop working before you’re eligible to access your formal pensions? Do you have a personal or company pension? If you’ve worked for a number of companies, you may have several. Have you considered consolidating your pension arrangements? Have you checked how your retirement funds are performing, and if your circumstances and ambitions have changed since you last reviewed them?
If you are earning more than you spend, it’s also worth thinking about what you’re doing with your excess income. Inflation erodes the value of savings over time, meaning your purchasing power in the future is reduced. Of course, everyone needs cash reserves, but could you invest more now, using tax advantages, so that your retirement ambition has a more certain outcome?
Less than 10 years until retirement
If you’re approaching retirement, you probably already have a rough idea of your retirement plan. It’s also likely that you’ve experienced some investment turmoil over the years which may have caused unease and uncertainty. When you have financial plans in place it can be tempting to just stick with your current investment arrangements, whether they are performing or not, or perhaps you have been thinking about making some changes but need guidance and advice. Professional advice at this time can help you feel in control of your finances and your future.
If you’re feeling unsure about the state of your investments, or how your finances are arranged, it’s important to find an adviser who can review your circumstances and discuss suitable options in order to address your objectives. As you near retirement, it’s even more important to review your appetite for risk, capacity for loss and complete a financial health check to assess whether you are on track. Often Investors are happier to take fewer risks as retirement approaches, but this is not always the best course of action. Consider that pensions may need to provide you with income for the rest of your life.
If you’re already retired, you’ll already be using your assets to fund your lifestyle. It’s certainly worth reviewing how you are using your assets to provide income. At this stage of life, many people’s financial goals change from investing for growth to investing for income. However, as people live longer, retirement is often broken into different stages, allowing you more control over how you structure your finances and access your wealth at a future date to deliver different benefits at different times.
To find out if your retirement dream is achievable take this short quiz here: https://www.arbuthnotlatham.co.uk/insights/retirement-quiz
Not company earnings, not data but vaccines now steering investor sentiment
By Marc Jones and Dhara Ranasinghe
LONDON (Reuters) – Forget economic data releases and corporate trading statements — vaccine rollout progress is what fund managers and analysts are watching to gauge which markets may recover quickest from the COVID-19 devastation and to guide their investment decisions.
Consensus is for world economic growth to rebound this year above 5%, while Refinitiv I/B/E/S forecasts that 2021 earnings will expand 38% and 21% in Europe and the United States respectively.
Yet those projections and investment themes hinge almost entirely on how quickly inoculation campaigns progress; new COVID-19 strains and fresh lockdown extensions make official data releases and company profit-loss statements hopelessly out of date for anyone who uses them to guide investment decisions.
“The vaccine race remains the major wild card here. It will shape the outlook and perceptions of global growth leadership in 2021,” said Mark McCormick, head of currency strategy at TD Securities.
“While vaccines could reinforce a more synchronized recovery in the second half (2021), the early numbers reinforce the shifting fundamental between the United States, euro zone and others.”
The question is which country will be first to vaccinate 60%-70% of its population — the threshold generally seen as conferring herd immunity, where factories, bars and hotels can safely reopen. Delays could necessitate more stimulus from governments and central banks.
Patchy vaccine progress has forced some to push back initial estimates of when herd immunity could be reached. Deutsche Bank says late autumn is now more realistic than summer, though it expects the northern hemisphere spring to be a turning point, with 20%-25% of people vaccinated and restrictions slowly being lifted.
But race winners are already becoming evident, above all Israel, where a speedy immunisation campaign has brought a torrent of investment into its markets and pushed the shekel to quarter-century highs.
(Graphic: Vaccinations per 100 people by country, https://fingfx.thomsonreuters.com/gfx/mkt/azgvolalapd/Pasted%20image%201611247476583.png)
SHOT IN THE ARM
Others such as South Africa and Brazil, slower to get off the ground, have been punished by markets.
Britain’s pound meanwhile is at eight-month highs versus the euro which analysts attribute partly to better vaccination prospects; about 5 million people have had their first shot with numbers doubling in the past week.
Shamik Dhar, chief economist at BNY Mellon Investment Management expects double-digit GDP bouncebacks in Britain and the United States but noted sluggish euro zone progress.
“It is harder in the euro zone, the outlook is a bit more cloudy there as it looks like it will take longer to get herd immunity (due to slower vaccine programmes),” he added.
The euro bloc currently lags the likes of Britain and Israel in terms of per capita coverage, leading Germany to extend a hard lockdown until Feb. 14, while France and Netherlands are moving to impose night-time curfews.
Jack Allen-Reynolds, senior European economist at Capital Economics, said the slow vaccine progress and lockdowns had led him to revise down his euro zone 2021 GDP forecasts by a whole percentage point to 4%.
“We assume GDP gets back to pre-pandemic levels around 2022…the general story is that we think the euro zone will recover more slowly than US and UK.”
The United States, which started vaccinating its population last month, is also ahead of most other major economies with its vaccination rollout running at a rate of about 5 per 100.
Deutsche said at current rates 70 million Americans would have been immunised around April, the threshold for protecting the most vulnerable.
Some such as Eric Baurmeister, head of emerging markets fixed income at Morgan Stanley Investment Management, highlight risks to the vaccine trade, noting that markets appear to have more or less priced normality being restored, leaving room for disappointment.
Broadly though the view is that eventually consumers will channel pent-up savings into travel, shopping and entertainment, against a backdrop of abundant stimulus. In the meantime, investors are just trying to capture market moves when lockdowns are eased, said Hans Peterson global head of asset allocation at SEB Investment Management.
“All (market) moves depend now on the lower pace of infections,” Peterson said. “If that reverts, we have to go back to investing in the FAANGS (U.S. tech stocks) for good or for bad.”
(GRAPHIC: Renewed surge in COVID-19 across Europe – https://fingfx.thomsonreuters.com/gfx/mkt/xegvbejqwpq/COVID2101.PNG)
(Reporting by Dhara Ranasinghe and Marc Jones; Additional reporting by Karin Strohecker; Writing by Sujata Rao; Editing by Hugh Lawson)
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