The UCITS ILS investor universe will naturally segregate between institutional and wholesale/advised clients, if the European Commission (EC) accepts recent advice from the European Securities and Markets Association (ESMA), sources have told this publication.
This would create opportunities for more tailored product offerings that are more specifically oriented to the different investor types.
However, overall managers’ preference is to continue with UCITS cat bond funds as they are currently structured.
ESMA has advised the EC to create a new sub-group of the existing Alternative Investment Fund (AIF) structures, which a source described as an “AIF lite”.
Existing AIFs do not have a pan-European retail passport, meaning not all European Union (EU) member states permit investments by individual investors who come through the investment advisory route.
The proposed new retail AIF/ AIF lite would overcome these restrictions. It would also potentially introduce more retail investor-calibrated rules to cat bond investing, on aspects such as fund concentration risk, liquidity and minimum entry bars.
One source noted that AIFs generally allow for less liquid or private market type assets, with protections for investors around valuation, liquidity and transferability. The proposed fund structure could therefore be suited to cat bond lites or private cat bonds as well as standard 144a cat bonds, as they are generally smaller, less liquid and differently structured.
“Clients will naturally be segmented, between those with, for example, a $200mn allocation and investors of $10k or $20k. In a commingled fund, that has always been a challenge,” noted a source.
UCITS funds allow a mix of retail/advised and institutional investors.
The change could mean that advised clients switch out of UCITS and into the new AIF lite funds, reducing overall cat bond UCITS assets under management (AuM).
Larger institutional mandates could be established as funds of one.
Figures from the European Fund and Asset Management Association (EFAMA) show that total AuM for UCITS funds was around $15.3trn ($15.8trn), and for AIFs was EUR8.0trn ($8.5trn), as of the end of 2024.
The ratio of UCITS to AIF AuM has been roughly steady at around 13:7 over the past five years.
Any shift in cat bond assets from one fund regime to the other would not move the dial on total UCITS assets, as UCITS cat bond fund AuM of $13.8bn accounts for 0.09% of total UCITS AuM.
However, UCITS cat bond funds stand for around 25% of total cat bond volumes, based on Aon’s mid-year renewal report figure of $54.3bn of notional outstanding. They comprise around 12% of total ILS AuM of $115bn, per Aon’s report.
UCITS cat funds are also among the fastest-growing strategies within the ILS segment, and have increased AuM by nearly threefold over five years, from $5bn as of 26 June 2020.
From a manager perspective, the current UCITS rules offer flexibility on investor type.
A source also points out that investor protections already apply according to current rules, since the Markets in Financial Instruments Directive (MiFID) covers retail clients in different classes across basic, informed and advanced.
“For high net worth, basically you say you are happy and understand the product,” they said.
EMSA’s recognition of cat bonds as a credible asset class was welcomed as a positive by market sources. The same is true of its view that cat bonds can be part of the 10% so-called “trash ratio” in a UCITS fund, which allows funds to invest up to that threshold in less-liquid alternatives.
The EC can adopt, amend or ignore advice
If the EC adopts the AIF lite approach, it would require new primary legislation at EU level.
In terms of timing, sources anticipate this could take 18-24 months to agree between member states, and 18-24 months to implement, at a minimum.
“We wouldn’t wait. We would build up an alternative vehicle, and certain clients would switch over,” said one manager.
They indicated this could apply to certain high net worth investors, including those in the Middle East and Asia Pacific.
The recommended structure would echo the European Long-term Investment Funds (ELTIF) regime, which is designed to allow investors to access long-term, real economy investments in Europe, including infrastructure, private equity and private credit.
Several sources point out that another option for the EC is “to just ignore ESMA’s advice”. They note there is a recent precedent for this outcome, as it happened with ESMA’s recommendations for ELTIF 2.0 within the past couple of years.
In support of the “just ignore” outcome, several managers also said ESMA’s advice seeks to fix a situation that isn’t broken, with UCITS cat bond funds having performed well and investors in the segment not having experienced gating. However, it’s true also that there hasn’t been the kind of major peak loss cat event that could cause that to happen in recent years.
Plenum Investment’s Cat Bond UCITS Fund Index recorded profits of 14% last year and 16% in 2023. The firm’s historic UCITS market data is available on the Insurance Insider ILS data hub.
One source likened a potential change in the regulation to the introduction last July of Article 6 of the Single-Use Plastics Directive, which mandates a tethered design for bottle tops on plastic bottles of less than 3 litres.
“It’s just annoying, and not solving a problem,” they said.
The changeover to a new structure would create a lot of additional work, such as changing custody bank, fund administrator and prospectuses, the source noted.
In other possible outcomes, the EC could amend ESMA’s advice, and/or conduct its own consultation.