Hong Kong as an Emerging Hub for ‘Cat Bonds’: Insurance-linked Securities Outlook

The debut ILS launch in October 2021 is instrumental to the development of the ILS market in the GBA. The GBA blueprint marks the insurance sector as a pillar industry, promoting cross-border Renminbi reinsurance business and exploring the development of a trading platform for innovative insurance elements.

Since the issuance of the first ILS, there has been significant growing interest from reinsurers and industry players to choose Hong Kong as the latest domicile for the issuance of ILS. 

Increased popularity of cat bonds

ILS is a financial instrument which allows insurers or reinsurers (commonly known as sponsors) to transfer their insured risk to capital market investors through securitisation.

ILS has gained immense attractiveness on a global scale. From a sponsor’s point of view, it acts as an alternative form of risk mitigation and method of raising capital, allowing sponsors to spread and alleviate risks. From an investor’s point of view, ILS has an attractive yield profile in comparison with traditional assets and acts as an alternative asset class which offers investors the potential for attractive risk-adjusted returns.

The following diagram illustrates the structure of a cat bond, the most common form of ILS transaction:

For an overview of the Hong Kong ILS regime, see our April 2019 and July 2020 client alerts.

Policy and legislative milestones

The timeline below sets out the milestones in the development of the ILS regime in Hong Kong:

Guideline on Hong Kong’s ILS Regime (GL-33)

Published by HKIA in June 2021, GL-33 sets out the requirements for SPI authorisation in Hong Kong. The key requirements are:

• Investment minimum of USD250k - the investment size for each ILS transaction must be no less than US250,000 (or equivalent in other currencies).
• Bankruptcy remoteness - the SPI must be “bankruptcy remote” in that it must not be a company within the same group of companies as the sponsor. Further, ILS investors must have no recourse to the assets of the sponsor (the reinsurance agreement between the SPI and the sponsor must include a clear and unequivocal limited recourse clause). A legal opinion is required as a supporting document to confirm the bankruptcy remoteness aspect. 
• Fully-funded - the SPI must be fully funded, meaning that its full liabilities must be fully backed by assets including funds raised through debt or other financing arrangements.
• Appointment of administrator(s) and directors - the SPI must have at least one individual administrator and two directors (all of whom must be fit and proper as per “Guideline on Fit and Proper Criteria” (GL-4)), with at least one of them being a resident in Hong Kong. 
• Appointment of auditor - an auditor must be appointed within one month from the date on which the SPI commences its special purpose business. 

In terms of selling restrictions, as per the SPB Rules, the sale of ILS is restricted to “eligible ILS investors”: certain qualified institutional investors such as banks and insurers (excluding funds targeting the retail public, for example SFC-authorised retail funds, mandatory provident funds and occupational retirement schemes). These restrictions must also be disclosed in the contractual and offering documentation for the ILS.

First and second ILS issuances in Hong Kong

King & Wood Mallesons (KWM) acted as the Hong Kong legal advisor for both the first and second SPI authorisation approvals granted by the HKIA. Specifically, KWM advised China Property and Casualty Reinsurance Company Ltd (acting as sponsor) on the issue of the first catastrophe bond in Hong Kong in October 2021, and recently advised Peak Reinsurance Company Limited (acting as sponsor) on the first catastrophe bond issued on a private placement basis in accordance with Rule 144A of the U.S. Securities Act 1933 (144A Cat Bond) issuance in Hong Kong in June 2022.

For further details regarding these transactions, please refer to our October 2021 and June 2022 news releases.

Follow-up ILS and a ‘growth’ outlook

The ground-breaking and successful launches of catastrophe bonds in Hong Kong since October 2021 attracted significant interest in the Hong Kong ILS market. There is great potential for the market to grow in supporting ILS to act as an effective tool for risk transfer and a class of alternative investment.

The Hong Kong ILS market is supported by the Grant Scheme, which offers reimbursement of eligible expenses attributable to issuing ILS in Hong Kong and specifically gives priority to first-time issuers and sponsors as well as issuances lodged with and cleared by the Central Moneymarkets Unit operated by the HKMA. The recent 144A Cat Bond issuance is also eligible for the Grant Scheme and is expected to be the first that utilises the Grant Scheme.

With the growing interest to strengthen the ILS market in Hong Kong from both new and existing industry players, we will continue to work closely with the HKIA in securing more potential opportunities and transactions to help Hong Kong develop into an international ILS hub. The growing intensity of the competition in traditional reinsurance also urges sponsors to consider obtaining reinsurance protection from the capital market investors.

Going forward, we expect to see developments of more diverse, innovative and sophisticated structures as well as settlement methods being tested in the Hong Kong ILS market. We are confident that the Hong Kong ILS market will continue to gain momentum in the years ahead.

For capitalized terms which are not defined in this alert, please refer to 'Sidebar - The Words We Use' in our foreword here.

Disclaimer: This alert is provided for general information purposes only and does not constitute legal advice.

References

[1]  https://www.artemis.bm/wp-content/uploads/2022/06/catastrophe-bond-ils-market-report-q2-2022.pdf?utm_source=ReportsPage&utm_medium=Link&utm_content=Q22022Report&utm_campaign=Q22022Report