Bond Market Association warns Congress of catastrophe bond market disruption

Christopher McGhee, head of insurance risk-linked securities trading at insurance and reinsurance broker Marsh & McLennan Securities in New York, told a US House of Representatives financial services subcommittee yesterday that pending accounting changes in the US could dampen new issuance of insurance risk-linked securities, commonly referred to as catastrophe bonds.

McGhee testified in his capacity as chair of the Risk-Linked Securities Committee of the US Bond Market Association (BMA).

He said that, as of last month, there were $2.7 billion catastrophe bonds outstanding, and added that since 1997, 45 catastrophe bond transactions have been completed, representing a total catastrophe risk transfer of $6 billion from insurance markets to capital markets.

A new proposed interpretation of an accounting rule by the US Financial Accounting Standards Board (FASB) could require investors with the largest equity stake in new catastrophe bond issues to consolidate an entire issue on their balance sheets if the issue has a less than 10% total equity component.

A similar issue vexed the collateralised debt obligation market after charges of accounting fraud at Enron and other US corporations hastened new tougher treatments of special purpose entities, or SPEs – the legal structures through which financial risk transfer is often accomplished.

“Any FASB proposal that results in an increase in the third-party equity requirements for …[insurance risk-linked securities]…or requires consolidation of the SPEs on the balance sheet of any other entity involved in the transaction would be severely detrimental to the market,” McGhee told the Committee of Financial Services Subcommittee on Oversight and Investigations.

One catastrophe bond investor said the market was aware of the issue, but though a burden would be imposed were the proposed revision to go through, a secondary trading market in the equity of catastrophe risk issues would likely develop in response.