Credit Suisse Bond Spotlights Cap Markets Risk Coverage

While Credit Suisse has no immediate plans to expand last week’s bond offering aimed at covering its exposure to rogue trading, serious accounting errors, cyberattacks, and other operational threats, the bank expects that other financial institutions might be interested in making similar moves.

The bank is also keeping an eye on how the capital markets respond to its largely unprecedented move of securitizing operational risks. To be sure, the bond attracted only enough investment money to provide 220 million Swiss francs (about $222 million) of coverage, a far cry from the 630 million Swiss francs at which the deal had previously been expected to sell.

Issued by Operational Re, a Bermuda-registered special purpose insurance vehicle set up by Credit Suisse, the bond will function as reinsurance on a 270 million Swiss franc insurance policy underwritten by Zurich Insurance Group.

Apparently tailored to lure wary investors with stringent risk underwriting, the insurance would be triggered only when Credit Suisse’s annualized covered losses exceeded 3.5 billion Swiss francs. Further, Credit Suisse would not gain claims payment unless at least two of the 23 or 24 covered operational risk events occurs. Regulatory fines and reputational risks aren’t covered under the Zurich policy.

While more details on the insurance policy were expected from Zurich by the end of this week, they‘re likely to be delayed by the circumstances of the death of the insurer’s former CEO, Martin Senn, last Friday.

Paul Schultz, Aon Securities

Although securitization of insurance risks into the capital markets has been going on at least since the 1990s, most of the activity has involved catastrophic property risks such as hurricanes and earthquakes, according to Paul Schultz, the chief executive officer at Aon Securities, a big player in insurance-linked securities.

“Over the past five years, we’ve been spending a lot more time thinking about other types of risks that can be securitized through a form that the capital markets like,” says Schultz, whose firm was not involved in the Credit Suisse deal.

One of the basic principles of insurance-linked securities is that they must provide capital markets investors with the opportunity to invest in assets that aren’t correlated with traditional equity or fixed-income markets, according to the executive.

“If there is an earthquake, for example, that doesn’t correlate to whether the interest rate or equity markets are going to go up or down. As you move from that natural catastrophe risk to other types of risks, there can be more correlation,” he said. “If there is some type of major [rogue] trading issue, that potentially could affect the markets, so you get a little more correlated.”

One operational risk that could very well make its way it way into the capital markets is that of a cyber attack. Although Aon has been working on the idea, “we don’t necessarily have a solution today that can be transferred to the capital markets to hedge against cyber risks,” Schultz told CFO. “But we do believe that over the next several years, the capital markets will be very much an integral part of the solutions that we create for clients for that risk.”