Standardization Paves the Way for New Cat Bonds
Lack of standardization is an obstacle to increased use of cat bonds. Ongoing efforts aim att simplyfing issuance and use of cat bonds, not least in developing economies, spearheaded by the World Bank.
A common difficulty with cat bonds, raised by risk carriers and investors alike, is the lack of standardization regarding bond issuance. This increases the administrative and legal burden for risk carriers wishing to sponsor a cat bond and complicates the investors’ process of scrutinizing bond prospects.
In most cases, this is not really a difficulty, but to new sponsors, such as governments in developing economies, it raises the threshold for issuing cat bonds. This, in turn, means a slower pace of new bond introductions and less diversification opportunities than could be the case.
The World Bank has for a long time been involved in financial instruments to mitigate climate related risks, including the increased use of cat bonds. To address the standardization problem, the bank created a framework that could be used by any government wishing to make use of cat bonds, offering a solid legal platform and the opportunity to use the bank as an arranger for setting up the bond.
The World Bank program, MultiCat, was set up in 2009 in close cooperation with the government of Mexico, which is also the only issuer to date to build a bond on the framework. Though this may seem a disappointment, the program has proven successful in Mexico so far and the Mexican bond, covering several different perils, was renewed when the first bond matured in 2012.
Though no other governments, to date, have issued bonds using the platform, it has served as example that further standardization is possible and to inspire a discussion about the development of mid-sized bonds, that would be difficult to issue without reduced transaction costs. Not least for developing economies, this would be an important development.
As always, things may seem to move to slowly. However, as efforts are underway, we are bound to see a number of standards for mid-sized bonds develop in the coming years. This is good news to countries in real need of improved insurance protection to provide disaster relief and to investors that will see further diversification possibilities, alike.