Hong Kong's upcoming ILS market attracts potential sponsors

A new insurance-linked securities, or ILS, market in Hong Kong that may be opening its doors soon is drawing interest from possible participants.

Aon Securities CEO Paul Schultz said in an email that "broad base" of potential sponsors from all over the globe have inquired about the prospective ILS market in Hong Kong. Aon Securities, Aon PLC's investment banking division, has received inquiries from Hong Kong- and mainland China-based insurance and reinsurance companies, as well as development banks.

As for the risk potential sponsors are looking to transfer to ILS investors, Schultz said most of the inquiries are for natural catastrophes like earthquake and wind. Responses have also included queries about pandemic, mortality and morbidity, and mortgage securitization. Schultz said it is likely that Hong Kong's first ILS transaction will occur in the third quarter of 2021.

Catastrophe bonds, which are securities that transfer specific risks from sponsors to investors, make up the vast majority of the worldwide ILS market. The market started to emerge in the late 1990s as insurance companies sought to lay off some of their exposure to major catastrophic events following heavy losses from Hurricane Andrew in 1992 and the 1994 Northridge earthquake in California.

The Hong Kong city skyline Source: Thinkstock

To facilitate the creation of an ILS market in Hong Kong, its government in July 2020 approved two amendments to the insurance ordinance. The first provides a framework for allowing issuance of ILS in Hong Kong through a special purpose vehicle, while the second enhances the regulatory framework for supervision of insurance groups where the holding company is incorporated in Hong Kong.

In an effort to entice potential sponsors, the Hong Kong Insurance Authority announced a pilot ILS grant scheme in May that covers the up-front costs of an eligible issuance. If the maturity of a security is set for three or more years, the subsidy will be the lesser of HK$12 million or 100% of the total up-front costs. If the maturity date is for less than three years, the subsidy will be the lesser of HK$6 million or 50% of total up-front costs.

To be eligible, issuances must occur in Hong Kong, be worth at least HK$250 million and at least 20% of up-front issuance costs must go to local service providers. First-time issuers and sponsors will be prioritized.

Peak Reinsurance Co. Ltd. CEO Franz Josef Hahn, whose company closed the first reinsurance sidecar — which lets outside investors take on both the risks and rewards of specified books of business — from an Asia-based sponsor in 2018, said the grant scheme will broaden the source of insurance and reinsurance capital, and support the closing of protection gaps in the fast-developing Asian market.

"The grant scheme and new developments in the ILS space will position Hong Kong into an attractive domicile for issuance of ILS," Hahn said.

Asked whether Peak Re is interested in issuing ILS in Hong Kong, Hahn said the reinsurer is focused on building out its platform. Peak Re is working closely with the Insurance Authority "on the ILS development of Peak Re," he added.

Potential regional rivalry

Hong Kong matched Singapore's ILS grant scheme, which funds 100% of up-front issuance costs of cat bonds in the city-state up to S$2 million, for ILS maturing in three or more years.

Singapore logged its first cat bond issuance in 2018 and has hosted numerous issuances since, including its first full cat bond under the U.S. Securities and Exchange Commission's Rule 144A, and the first Asian cat bond covering typhoon and flood risks in Japan. In 2020, the country extended its ILS grant scheme for an additional two years.

Schultz said that while the incentive schemes are important for sponsors, it is also important to see a robust platform of local service providers with healthy competition, a moderate, relatively loose regulatory environment and flexibility to adapt the regulatory framework to the needs of sponsors and investors.

He added that sponsors are seeking "timing and process certainty" similar to that of the Bermuda market in order to not "disrupt the overall transaction timeline."

As of July 2, US$1 was equivalent to S$1.35.