Hong Kong gearing up to become a hub for ILS such as catastrophe bonds, Insurance Authority says

City must create an ecosystem for insurance-linked securities, IA CEO Clement Cheung says
IA has been selective with issuances to achieve a long-term solution that can leverage the strength of Hong Kong to serve first the Greater Bay Area, and, if possible, China and the region: Cheung

Business of climate change

Aileen Chuang

Published: 9:00am, 15 Apr 2024

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Hong Kong is building an arsenal to assist the world with raising funds for managing losses from natural disasters, the Insurance Authority (IA) said. The city is discovering more issuers, investors and data, as well as cultivating its modelling capabilities and talent.

As an international financial centre, Hong Kong has shown the potential to become a hub for global insurers and supranational organisations issuing insurance-linked securities (ILS), after the World Bank listed its US$350 million catastrophe bonds in the city in March last year.

But what is more important is for the city to create an ecosystem, said Clement Cheung Wan-ching, the IA’s CEO.

“Our first mission is not to talk about the hub,” he said. “The first mission is aiming at resolving this huge protection gap on natural catastrophes, which exists around the world [and], in particular, in this region and China.”

Catastrophe bonds, or cat bonds, are a type of ILS that transfer risks associated with exceptional weather events to capital markets, giving the insurance industry greater capacity to underwrite more risks. In 2023, the issuance of cat bonds rose by 8 per cent to a record high of US$15 billion globally, according to reinsurance firm Swiss Re.

While the record figure signals investor interest and growing demand for catastrophe risk management, it is still far short of the scale of natural disaster-related losses. According to German reinsurance firm Munich Re, last year natural disasters cost the world US$250 billion.

The Asia-Pacific region and Africa were among the most vulnerable, with only 12.5 per cent of losses being insured in 2023, well below the global average of 38 per cent. That number was even lower in China, with only about 5 per cent being covered by insurance.

“Hong Kong can do a lot to fill this gap,” said Cheung. He pointed to the city’s strong capital market, government support and financial infrastructure, all of which could develop its ILS market further.

In the budget announcement in February, Financial Secretary Paul Chan Mo-po said the government is keen to promote the development of ILS by establishing a dedicated regulatory regime and the launch of a pilot grant scheme in 2021. Since 2021, the city has raised US$562.5 million through four cat bond issuances.

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However, the last such issuance was over a year ago by the World Bank, raising questions about the city’s efforts.

The IA’s Cheung said that the government agency has been selective with issuances to achieve a long-term solution that can leverage the strength of Hong Kong to serve first the Greater Bay Area (GBA), and, if possible, the larger part of China and the region.

“We are not just about boosting issuances – we’re talking about whether we can build a system,” Cheung said.

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The IA is in talks with various potential issuers, including international reinsurers, direct insurers and Chinese municipalities, according to Cheung. It is also networking and educating investors through conferences.

Cheung said one reason behind the low insurance coverage for natural catastrophe risks is the lack of data. The IA is determined to discover more climate data within the GBA and Asia while developing modelling capabilities with universities in Hong Kong.

“The question is whether we discover the risks and make sure that the risks can be accumulated, packaged and put into an ILS,” Cheung said. “That’s where the ecosystem will work.”

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“I believe we are going to have issuances every year from now on. We set our KPIs [key performance indicators] so that we should have regular issuances, but we have to work on more sponsors, different issuers and product types.”

Singapore, for example, has innovated in this area after two cybersecurity cat bond offerings last year. The city state also renewed its ILS grant scheme to support issuances covering longevity and mortality, according to the Monetary Authority of Singapore.

Jorge Familiar, vice-president and treasurer of the World Bank, said that ILS is essential to disaster risk management and provides investors with asset diversification.

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“The asset return that insurance-linked securities provide to investors is related neither to interest rates nor to the behaviour of capital markets,” he said. “It’s an interesting instrument for providing diversification to a diversified portfolio of assets.”

The World Bank’s cat bonds in Hong Kong last year secured Chile against financial risks brought about by earthquakes. The notes will mature in three years with a floating rate – Bloomberg has estimated a coupon rate of 9.56 per cent.

“We would certainly like to continue with this partnership [with the IA], to see our efforts materialised in more transactions,” Familiar said.