My Market is bigger than yours…but size is not everything!

The London Market Group (LMG) and Boston Consulting Group (BCG) recently published a report on the London Market, which provides a useful overview of some of the relative scales and characteristics of the world’s (re)insurance markets, as well as hinting at issues and themes that are likely to become more important in the future for all market participants.

From the point of view of Bermuda, it is worth noting that, while in primary commercial insurance, the London Market is almost four times as large as Bermuda with 2013 GWP of GBP 30.5BN equivalent (vs. GBP 8.5BN); in reinsurance, Bermuda is larger than London, at GBP 16.1BN vs. GBP 14.6BN, which is remarkable when one considers the relative scale of the resources committed and available in each market.

However, the more interesting component of the report is perhaps its comparative analysis of the strengths and weaknesses of the world’s key insurance markets, which it considers to be London, Switzerland, Hong Kong, New York, Bermuda, Singapore and Dubai in ranked order. While one could certainly detect an element of self-promotion, it is worth noting that the report asserts that Bermuda is weaker than average in terms of access to market, pricing and speed of placement; but better than average in terms of product and risk expertise, ability to generate capacity quickly, and speed and willingness to pay claims. Frankly, from the point of view of Insureds, it seem to us that Bermuda’s advantages outweigh the supposed disadvantages. It is also worth noting that London’s expense ratios were 9% above that of its peers; something which, in an increasingly price-competitive market has to be cause for concern, as well as raise questions as to how it can be addressed.

As we have written before, the “traditional” (re)insurance market faces a number of threats; and, in this regard, the report is useful for enumerating some of the more important ones, which not only affect London Market participants, but all markets:

• Increasing mobility and local availability of underwriting expertise
• Use of data and analytics in underwriting decisions
• Emergence of new risks for which insurance solutions are not yet available
• A growing protection gap in NatCAT
• Higher growth, emerging markets as a key source of premium growth
• A superabundance of capital and increasing securitization of insurance risk
• Technological impacts on supply chains and often antiquated insurance infrastructures.

To the Awbury team none of this is surprising; and we devote considerable effort to ensuring that not only do we stay on top of market changes and developments; but that we can continue to deliver capacity in whatever size is needed across all major markets through our extensive network of highly-rated (re)insurance partners, as well as focusing on the E-CAT market, which is not commoditized, nor correlated with the more traditional markets such as NatCAT.

-The Awbury Team

TLAC that…or would you rather MREL? Warning: Acronym Overload!

Anybody who operates in the world of finance will be aware that it is beset by an ever-expanding array of acronyms, of which the two in the title of this piece are just a foretaste of the next stage of what is to come in banking regulation.

The former stands for Total Loss Absorbency Capacity and is an acronym that arrived with the recent Financial Stability Board (FSB) consultation paper on resolving  the now 30 Global Systemically Important Banks (G-SIBs); the latter stands for Minimum Requirement for own funds and Eligible Liabilities and is a concept that forms a key component of the European Union’s new Bank Resolution & Recovery Directive (BRRD.)

Both concepts, and the regulatory structures of which  they form a part, are the foundation of attempts to end the concept of Too Big (or Too Important) To Fail (TBTF/TITF), which resulted in the expending of hundreds of billions of tax Dollars, Pounds and Euros by governments desperate to avoid the total collapse of the global banking system and the socialization of risk for the benefit of shareholders and bank managements.

Not surprisingly, such largess not only severely strained many sovereign balance sheets (cf. Iceland and Ireland), but also led to the hunt for mechanisms that would either provide support to re-capitalize solvent but distressed banks, or, if they were beyond saving as going concerns, the resources to enable them to be “resolved” in ways that did not require further funds form the public purse.

While the detail and complexity of both the FSB proposal and EU Directive can cause synaptic overload (as is now increasingly the case with much regulation), their basic premise is fairly straightforward- namely that affected banks will need to comply not only with minimum capital requirements (as under Basel III, Fed rules, or the equivalent) for equity and other subordinated capital, but also to ensure that their balance sheets will contain sufficient other liabilities that can be used to absorb losses and write-downs on the asset side. Naturally, this sets the stage for some interesting discussions about which liabilities should or should not be included; how liabilities should be ranked; and even whether or not the ranking of existing obligations need to be changed (something explicitly contemplated by the FSB proposal). Full implementation of both TLAC and MREL should be expected by 1/1/2019. This may seem somewhat deferred, but the ramifications and consequences of the new requirements, as well as the planning needed to implement them, are significant; and will further distract bank managements from their core businesses.

All that being said, why should we at Awbury care about such matters?

While both developments are symptomatic of the regrettable secular decline of banks as providers of funding and many once “essential” businesses, as they face ever more onerous capital and other constraints, they also offer continuing opportunity to Awbury and its (re)insurance partners to provide our bank clients with solutions that not only assist with capital relief as now, but also will enable them to meet the burden of both TLAC and MREL in ways that are flexible, tailored and cost effective. In addition, using insurance-based structures, Awbury can offer its broader client base proven alternatives to replace those products either no longer available from their banks, or for which the cost is rapidly becoming uneconomic.

-The Awbury Team

The Good Old, Bad Old Days?

We must admit to having a feeling of “déjà vu all over again” as we watch the value of the Russian Rouble sink rapidly in the East, having lost roughly 50% of its value against the US Dollar over the past year; and as reports begin to appear of Russian banks seeing queues form of customers seeking to buy US Dollars in an attempt to preserve some of their wealth via a currency that for all its supposed faults is still the global hegemon.

And when one couples that with the idea being broached of the Duma passing legislation that would, in effect, make the holding and use of US Dollar cash illegal for almost all of the population, one begins to wonder whether the shocks of 1998 and 2008 are about to be repeated. It should not be forgotten that in 1998 the then government deliberately and explicitly defaulted on its domestic currency GKO obligations, while continuing to honour its external obligations such as MinFins and the like- something which is rare, even in the idiosyncratic and episodic world of sovereign default, and not the same as the “soft defaults” that occur in places such as Venezuela and Greece, to name a couple.

Of course, Russia is not the Soviet Union (although President Putin clearly has revanchist goals on Russia’s western Marches, and is probably causing apoplexy in Warsaw at present with his seeming defence of the infamous Molotov-Ribbentrop Non-aggression Pact and its Secret Protocol); and the fact that Russia’s major exports are largely US Dollar-denominated provides a significant fiscal hedge, as long as the prices of crude oil in particular do not decline further. Nevertheless, the Central Bank’s attempts to stem the Rouble’s collapse, in spite of raising rates and expending significant portions of its foreign exchange reserves, have largely proved fruitless, generating rising concern that some form of capital and exchange controls may have to be introduced to “stop the rot.” The fact that the so-called ceasefire in the eastern Ukraine is beginning to unravel simply adds to the sense of unease.

As if that were not enough, inflation is rising; the economy is close to, if not already in recession; and the effect of sanctions is increasing autarchic tendencies.

So, the question arises as to whether, in spite of Putin’s still very high “approval ratings” and seemingly unchallenged internal authority, the regime may be somewhat more “brittle” and vulnerable than market pricing on sovereign debt and for CDSs would lead one to believe; and whether there is now a higher probability of government actions that will have a material negative impact, not only on external investors and lenders, but also on those writing trade credit and political risk covers.

We at Awbury pay close attention to such developments around the world, because we believe that it is essential to update constantly our understanding and assessment of the risks in key markets, so that we can continue to underwrite and price the transactions that our multi-national client base brings to us; and maintain a robust relationship between risk and reward.

-The Awbury Team

Is it really over?

The ECB/EBA announcements of the results of their complex series of stress tests, comprehensive assessments and asset quality review (AQR) generated quite a lot of sound and light, but not much fury- apart from the Italians.

Apart from Monte dei Paschi, none of the “failures” were seemingly that significant in terms of scale and impact. However, dig a little deeper and a number of questions emerge, which make the Awbury team believe that there is more to ponder than may at first be apparent.

With one minor exception, all the German banks in the sample “passed” the various tests, albeit in some cases by a modest margin. Given the structure of the banking system; its experience and performance during the financial crisis; and the outlook for the German economy, we must admit that we find that “fact” a little surprising. Obviously, the counter-argument would be that they were all subject to the same tests as everyone else, but we cannot help having a lingering suspicion that all is not quite as it seems. Sadly, only the next financial crisis will demonstrate whether our suspicions are well-founded, or based on our cynicism about the true rigour of the process and the scope for “judgement” being exercised. For example, of the 16 banks that came closest to not meeting the minimum 5.5% CET1 ratio under the adverse stress test scenario, 7 were German.

While banks passed under the parameters set, those were at a point in time and lacked a number of relevant forward-looking inputs. As such, applying a “fully-loaded” Basel III capital requirement, which is being phased-in over the next few years, would have caused a number of additional “failures”.

Over four fifths of the banks surveyed were found to have under-provisioned in some way, whether by over-estimating values or having a feeble level of loan loss reserve coverage. The aggregate adjustment made was some EUR 136MM, a not insignificant sum. Given the inherently high-leverage within banks; the amount of wrong-way risk they often have; and the tendency for realizable values to plummet in a stress-scenario, we believe that, in the real world, the situation would be even worse than the outcome of the AQR. The banks’ annual results for 2014 may give more clarity on this point.

The analyses were not based on market valuations; and so we wonder whether in a future systemic crisis, when correlations tend to rise; the herd rushes for the exits; liquidity disappears; and the amount of “linkage” between banks becomes more apparent, the banks would really have the capital buffers the ECB/EBA tests would have us believe.

You may call us cynical and perhaps even self-serving, but no matter what every “test” published to date, whether in the EU or the US, has shown about the “soundness” of a banking system, every subsequent systemic crisis has evidenced that their results and comforting prognostications were, in fact, a sham. Banks as currently structured are still inherently unstable and overly complex institutions.

Frankly, we are much more comfortable with the risks posed by a diversified and unleveraged P&C (re)insurer; and we believe that our clients recognize that in terms of their own view of counterparty risk and the probability of the protection they have sought being “good” in all realistic scenarios.

-The Awbury Team