It will end in tears…

The Awbury Team is sufficiently long in tooth to have experienced most of the financial markets’ quirks, foibles and frequent irrationality. We are, therefore, somewhat concerned to see signs that almost invariably presage quite a number of the innocent and not-so-innocent losing their own or somebody’s else’s money in large quantities and for reasons that should and could have been avoided.

We were reminded of the market’s seeming ability to ignore the obvious and remain in denial by reading Michael Lewis’s wonderful tragi-comedy of a book, “The Big Short”, with its damning portrayal of the combination of hubris, greed, mendacity and sheer stupidity that enabled the exponential growth of a market, US sub-prime mortgages, whose implosion in and after 2007 very nearly brought down the global financial system.

What then, are some of the signs now that cause us concern? We would highlight two themes, in different markets, which share a common characteristic- the weakening of contractual terms in bank loans documentation; and (re)insurers seemingly increasing willingness to relax the terms and definitions they permit in policies covering NatCATs.

In the former case, not only is issuance still increasing and credit quality declining, while spreads are at historic lows, but the “covenant-lite” approach to loan documentation has returned with a vengeance, meaning that when things go wrong, the lenders, or those who buy bank-originated “leveraged loans” are at a considerably greater risk of being well and truly “sc****d- yet are seemingly so desperate for yield that they are willingly accepting such an inevitability.

In the latter case, there are persistent reports that at least some (re)insurers are accepting policy terms that mean that when a CAT occurs the claims they will face will be considerably larger, because the definitions of what is covered under an Event have been amended in a way that favours the purchaser of the protection- and all this in an environment in which rates continue to fall. Sheer folly!

Not surprisingly, regulators have begun to notice and express concern about such trends; but, as yet, they have not taken concrete, targeted action to rein in the activities of their charges, so we are concerned that tears will flow before they do so.

At Awbury, we are somewhat paranoid about reading the fine-print; and aim to craft terms in the policies we issue for our transactions that are fit-for-purpose, thereby creating a properly-defined and understood risk/reward outcome, in which we, our clients and our partners are not exposed to risks for which they are not being (more than) adequately compensated.

-The Awbury Team

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