Greater Bay Re, an insurance-linked securities (ILS) special purpose vehicle (SPV) that is backed by both state-owned China Re and the state company’s subsidiary China Property and Casualty Reinsurance, issued the bond. Aon was responsible for marketing the bond, which covered areas of mainland China that are particularly exposed to typhoon risk, to specialist funds and investors.

The Hong Kong Insurance Authority’s (IA) CEO, Clement Cheung, said at the time that Greater Bay Re could be the first of many such vehicles to emerge from the mainland and the wider region.

“This decision of a leading state-owned reinsurer not only exemplifies the potential and attractiveness of Hong Kong as an emerging ILS hub but also demonstrates our crucial role as a global risk management centre,” he added.

Hong Kong is striving to catch Singapore in the race to become the regional leader of ILS issuances, after the Southeast Asian city launched an ILS grant scheme in 2018.

Fiona Chan, a partner in the corporate department of Appleby’s Hong Kong office, told Conventus Law that while Hong Kong would likely catch Singapore soon it needed to look further afield for long-term development inspiration.

Starting position

The Hong Kong Legislative Council (LegCo) passed two insurance ordinance amendments in July 2020, paving the way for the creation of special purpose insurers (SPIs) capable of issuing ILS. The amendments came into operation on March 29 this year.

The IA published initial details of its two-year pilot ILS grant scheme in May, with the regulator noting that the scheme would incentivise insurance companies and organisations to issue ILS products in Hong Kong. The scheme offers grants that cover some of the costs of cat bond issuances.

The Hong Kong government hopes the scheme will speed up the city’s emergence as an ILS hub to rival Singapore and Bermuda, and the Greater Bay Re issuance is widely seen as an essential step in that journey.

Celine Tan, associate director of business development at HSBC’s issuer services division, told Conventus Law that the Hong Kong ILS market was well-positioned to support the growing needs of sponsors and cedents in Asia.

She said: “The global ILS market is US overweight, given the maturity of the asset class, having started in the 1990s. There is a demand from institutional investors to diversify their ILS holdings and, for Asia-based sponsors, there is a real urgency to be able to hedge their risks against the increasingly extreme weather catastrophes occurring due to climate change.”

Climate concerns

ILS products are of increasing importance given rising concern over the adverse effects of climate change. The UN Intergovernmental Panel on Climate Change warned in August that the world would fail to limit global warming to 1.5°C or even 2°C by 2050.

Tan said ILS products should be viewed as environmental, social and corporate governance (ESG) instruments, which allow governments access to the necessary capital for infrastructure rebuilding following natural disasters.

She added: “Climate related CAT bonds, such as typhoon and earthquake bonds, are expected to become commonplace in the foreseeable future.”

Chan, meanwhile, said insurance claims had only accounted for less than 1% of direct economic losses arising from major disasters in China, including snowstorms and earthquakes, in 2008-2010.

She said: “Growing concerns relating to climate change and the pandemic across the Asian region generally also present increasing opportunities for the (re)insurance and captives markets and issuance of ILS products.”

An anticipated uptick in the frequency of natural disasters in Asia in the coming years has significant implications for the Chinese government’s Belt and Road Initiative (BRI) and Greater Bay Area (GBA) infrastructure initiatives.

The BRI aims to develop a global network of trade routes that deepen economic ties between China and the rest of Asia, the Middle East, Africa and Europe. The GBA, meanwhile, will integrate the Hong Kong economy with those of 11 cities across Southern China. However, while these initiatives will boost economic development, they will also generate additional risk tied to natural disasters.

As such, there will be new opportunities for ILS product issuances and the potential for Hong Kong to emerge as a regional ILS hub. Still, the city continues to face competition from Singapore as it strives to become as synonymous with ILS products as Bermuda.

Weighing the competition

Singapore’s ILS grant scheme, which covers 100% of certain upfront issuance costs, launched in 2018 and since then the city has hosted 13 cat bond transactions. Four of those took place this year, with six in 2020 and three in 2019.

Despite this initial success, the Monetary Authority of Singapore (MAS) is not standing still and has launched a market consultation process as it tries to streamline the regulatory environment surrounding ILS issuances. Although Hong Kong is playing catch up with Singapore, its unique position within the wider Chinese economy gives it a powerful advantage.

Chan said: “As the gateway of China to the world and a key component of the GBA, Hong Kong will continue to participate in various GBA initiatives that aim to promote ILS, as announced by different mainland authorities at both state and local levels since 2019.”

However, Chan also said Hong Kong’s ILS market was very much “in its infancy” and that it had a long way to go before it could be compared with the developed and matured industry in Bermuda, whose insurance regulatory framework was established in 2009.

She said: “The new ILS regime in Hong Kong should best be viewed as an opportunity to access and open up new opportunities in Asia, drawing on the experience and structure of Bermuda, thereby allowing synergy and collaboration across the regions.”

Bermuda’s ILS market has thrived for a handful of very important reasons, foremost of these is the island’s robust legal and regulatory framework that is perpetually updated. For example, Bermuda introduced new collateralised insurance and limited purpose insurers in 2019 in order to reflect the expanding scope and sophistication of the ILS market.

Moreover, financial regulator Bermuda Monetary Authority (BMA) has not only pursued the highest international standards but has also actively consulted with industry stakeholders to gauge their concerns.

Chan said: “The early achievement of Solvency II equivalence and the continuous recognition of other international standards are essential for Bermuda to maintain its dominance in the insurance industry and provide confidence to international investors.

Through the BMA fulfilling the role of one single responsive and engaging regulator, all of these reasons help to place Bermuda in a leading position in ILS, reinsurance and captive insurance markets.”

She added: “This also demonstrates the importance of Hong Kong pursuing a solid and adaptive legal and regulatory framework.”

Next steps

Both Bermuda and Singapore launched their ILS product offerings with cat bonds, which are the most common form of ILS products, and Hong Kong has unsurprisingly followed in their footsteps.

It took years before Bermuda diversified its ILS portfolio and Singapore’s offerings are still limited to cat bonds. While there is some corporate interest in other product offerings in Asia, the market lacks diverse providers of other types of insurance such as directors and officers (D&O) liability, professional indemnity, cyber risks and healthcare, to name but a few.

Chan said: “There is no doubt that HK has significant opportunities to develop the ILS market and to become the hub for ILS business in Asia. But it will take quite some time for Hong Kong, and Asia in general, to see widespread issuance of non-catastrophe ILS.”

As such, cat bonds are likely to dominate the Asia market for a long time to come, given the frequency and severity of natural disasters across the region.