Can Turning Up the "Volume" on Cat Bonds Create Transparency?

In an effort to address the transparency concerns of sponsors and investors, catastrophe bonds dealers are considering showing trading volume on the secondary market within circulated weekly pricing sheets.

But industry professionals say how to present the numbers could pose myriad of challenges.

The lack of depth of trading in the secondary market, inconsistent disclosure practices and regulatory overlap are just some of the problems facing the push for disclosure.

“We are all for transparency if it brings more assets into the space,” says says Paul Schultz, president of Aon Benfield Securities. “But the industry has struggled to find the right metrics to disclose.”

Currently several dealers — including Swiss Re and Aon Benfield — send out “pricing sheets” to institutional investors that show where existing catastrophe bonds are trading on the secondary market.

While the sheets reveal prices they do not show how many bonds are being traded.

Several professionals suggest that including volume statistics in the weekly pricing sheets would entice both sponsors and investors since it would show the “depth” of the market. Trading volume is often disclosed on other fixed income markets.

“Many of the quotations are insufficient for a transparent and vibrant market,” said Insa Adena, head of advanced risk intermediation at Allianz during a IQPC Insurance Linked Securities Summit earlier this year. “We need number such as tradable volumes so we can’t put these prices on the sheets into perspective.”

Any push by the brokerage community towards additional volume data would need to be standardized, says Albert Selius, portfolio manager with Securis Investment Partners Greenwich, Conn.
“Volume can be measured different ways,” he says.
Selius explains that while one broker may count purchases and sales of catastrophe bonds towards overall market volume numbers while another broker could count bonds, industry loss warranties (ILWs) and weather derivatives.
“Since brokers never take a principal position in a cat bond they may not count trades in the same way,” he says. 
Also, volume data may be easily skewed by external forces since the market for catastrophe bonds is relatively small when compared to other fixed income instruments.
For example, in 2008 trading volumes represented 50 percent of outstanding issuance and a signaled a relatively liquid market in catastrophe bonds. 
However, Selius points out that was a unique because most of those trades were “sell” orders by large multi strategy hedge funds looking to liquidate assets and raise cash during the financial market crisis.
“If you look at the year before and the year after 2008, those trading volumes may be 25 to 35 percent of the market,” Selius says.

Getting access to the volume information would not be a major issue since all catastrophe bonds are reported into the Financial Industry Regulatory Authority‘s (FINRA) Trade Reporting and Compliance Engine (TRACE).

TRACE was created in 2002 as a way reporting of over the counter secondary market transactions in eligible fixed income securities.

However, since catastrophe bonds are considered a “private market” by FINRA the volume numbers are not disseminated.

Schultz argues that moving away from the “private market” definition of catastrophe bonds could provide its’ own list of issues from regulators and industry participants.

“There is a split between those who want more disclosure and those that want it to stay private,” he explains. “Newer investors to the space and want to understand what’s going on as they allocate more assets to this class while there are others that feel very comfortable in the private market.”

Some dealers already provide the volume numbers when asked. “Swiss Re is happy to provide trading volumes on an ad hoc basis. Swiss Re traded $218 million of bonds in the first quarter of 2010,” says Richard Pennay, vice president of Swiss Re Capital Markets.

However, total market volume numbers remain elusive even though FINRA continues to collect the data.

“When someone says that there is not enough transparency, my answer is that we are doing everything we can to create transparency like putting up out indicative marks on a weekly basis,” says Aon Benfeild’s Schultz. “For every single trade there is a database of trade information. We do report this, but regulation makes it difficult to disclose every piece of information.”

However the volume debate is settled, Selius says that the push for greater transparency is will continue as new investors enter the asset class.
“The question that institutional investors like pension funds and endowments most often have in regards to ILS is ‘How can you price this risk,’” he says, adding that pension funds are particularly concerned about the opacity of pricing reinsurance contract and ILWs investor.
“They want to know you are getting in at the right level and getting out at the right level, he says. “That’s why secondary volume is important; its some proof of where the market stands.”

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