The current period of spread widening and uncertainty in the catastrophe bond market has been driven largely by external forces, rather than losses, according to Aon, leading the broker to suggest it will be “relatively short-lived.”
We explained last week that spreads have been widening across practically all new catastrophe bond issuances and that Artemis market sources have been talking about a mismatch, on multiple counts, that is having the effect of driving prices higher.
Aon’s Reinsurance Solutions broking unit and Aon Securities explained in the firms latest market report that it is largely external factors driving this trend.
A little like how the cat bond market reacted after the outbreak of the COVID-19 pandemic, the broking group believes the uncertainty and dislocation will be short-lived, with an equilibrium likely to be found as global investor sentiment settles down again.
Explaining that catastrophe bond market momentum carried on from the record 2021 cat bond issuance into 2022, Aon noted that, “Issuance pipelines continued to expand early in 2022 as cedents looked to capitalize on favorable pricing and terms.”
But as the world fell into another period of volatility and uncertainty, triggered by geopolitical events in Ukraine and other factors such as inflation, things have very quickly reversed for cedents, with capital essentially becoming more expensive, it seems.
“Recently though, the geopolitical turmoil and currency volatility have reduced the ILS investors’ investable cash (currency hedging, redemptions and a need for increased liquidity have all been cited) leading to a reversal of the tightening trend,” Aon explained.
Adding that the cat bond market is now seeing, “Most transactions now pricing around their wide end of spread guidance.”
There’s more to it than just volatility and general investor sentiment and risk aversion though, it’s also led to a mismatch in the amount of capital needed to satisfy all cedents in the pipeline and what the cat bond market investor base has available.
Aon continued, “Coupled with a robust pipeline, this has also led to increased investor selectivity in risk selection and a push for improved structural terms.”
This is where the mismatching of market ambition and investor capital availability, as well as appetite, has become most evident it seems.
Aon thinks this won’t last too long though, likely subsiding as global volatility settles down a little.
“We would expect the current market uncertainty to be relatively short-lived, as the shift was not driven by losses but rather by external forces,” the broker said.
Concluding, “We believe that new entrants and fresh capital will continue to return to the space once the broader capital market volatility recedes.”
As we said, the catastrophe bond market experienced similar uncertainty due to external forces when the pandemic outbreak began, with investor sentiment becoming more risk averse and investors generally distracted by financial market volatility.
This time, it does seem similar, as many cat bond fund managers are citing challenges in securing new capital inflows to match issuance at this time.
But then there has also been a mismatch in terms of the size of the pipeline, versus available capital from maturities as well, which has exacerbated the issue as free cash is not as abundant as it had been, among the larger managers of cat bond funds.
As ever though, the catastrophe bond market is relatively efficient in many ways, although still very manual when it comes to placement and distribution, which means it should still be able to satisfy most cedent needs effectively.
But, for the moment, it’s clear that cedents will not secure the pricing they may have hoped for a few months ago, when they likely began planning their issues, with wider spreads likely to remain a feature until geopolitical and capital market volatility settles down considerably.