Where ILS and ESG intersect

What does ESG mean?

ESG stands for environmental, social and governance. ESG criteria are standards for a company’s operations that investors use to screen potential investments.

Environmental criteria consider how a company’s operations impact the natural environment and climate. Social criteria examine how a company manages relationships with employees, suppliers, customers and the communities where it operates.

Governance deals with a company’s leadership, executive pay, audits, internal controls and shareholder rights.

As a member of the World Federation of Exchanges (WFE), the Bermuda Stock Exchange (BSX) acknowledges its role as a leader to promote the development of a sustainable approach to the financial system and to take actions towards a sustainable economy and financial future for current and future generations.

The BSX has embraced the WFE’s five sustainability principles:

Why is the BSX looking at this?

Stock exchanges are at the intersection between capital market players and their increasing responsibility to ensure that business practices are geared toward positive ESG practices. For example, on the environmental front we are seeing insurers such as Chubb and AXA XL pulling back their exposure to the coal sector.

Banks such as JP Morgan, Bank of America and Citi have also committed to ending funding for new coal mines and plants in ‘high income’ countries. As ESG standards become increasingly important and formalised, the BSX is moving forward in encouraging and empowering social impact investing and compliance with best market practices thereby driving sustainable finance.

How is its importance increasing for investors?

The emerging trend for entrepreneurs, investors and businesspeople is to incorporate ESG initiatives when investing and doing business.  This trend will only become more important in the future.

As climate change, social awareness and transparent governance become more important, at the BSX, we see this as an opportunity to help our member companies move forward with an ESG agenda that will assist communities adapt to a changing world in terms of environmental change, social issues and more transparent governance.

In 2006, when the UN-backed Principles for Responsible Investment (PRI) was launched, 63 investment companies (asset owners, asset managers, and service providers) with $6.5 trillion in assets under management (AUM) signed a commitment to incorporate ESG issues into their investment decisions.

By April 2018, the number of signatories had grown to 1,715 and represented $81.7 trillion in AUM. According to a 2018 global survey by FTSE Russell, more than half of global asset owners are currently implementing or evaluating ESG considerations in their investment strategies.

In the evolution of what is known in the insurance industry as the “convergence” of the capital markets and insurance markets, alternative reinsurance and third-party capital have contributed to innovative and technology-embracing advances in the industry.

Taking a longer-term view, we expect the capital markets to be a substantial carrier of natural disaster insurance risk. Insurance-linked securities (ILS) and catastrophe bonds as an asset class are a natural fit for certain sophisticated investors as they offer an ESG-relevant investment opportunity, coupled with diversification features of an asset class exhibiting little or no correlation to broader financial market returns.

ILS investors could actually speed up the transformation of the asset class into a more responsible investment opportunity with a measurable impact on society. Coverage can also be tailored to respond to sponsors’ needs in order to support better disaster preparedness.

How do ILS deals fulfil some of these criteria?

Pension fund investors from several jurisdictions have highlighted the social and environmental aspects of ILS and catastrophe bonds as they provide financing and liquidity when natural disasters strike. Certain ILS structures are recognised as sustainable investments and are aligned with the UN Sustainable Development Goals (SDGs), helping build resilience to disasters and climate change.

Bermuda is the centre of the ILS market and the BSX is the world’s leading exchange for the listing of ILS. Of the 1,013 securities listed on the BSX, ILS comprises 381 listed issuers, with $34.53 billion in market capital outstanding. Many of the BSX’s listings are focused on developing their ESG potential.

Forward-thinking ILS fund managers, hedge funds and asset managers based in Bermuda have long embraced sustainable investment principles and offer the potential investor the confidence of cemented credentials, impressive track records, and an established commitment to ESG values.

The catastrophes of the last few years including hurricanes, floods, typhoons and wildfires have not diminished investor appetite in the ILS market and it is becoming increasingly appropriate as a vehicle for responsible investments.

What questions has the BSX received from investors relating to ILS and ESG?

One of the challenges facing investors is that there isn’t a consistent global standard for ESG ratings. As someone frequently in touch with rating agencies, I know they are moving swiftly to establish criteria for ESG ratings. Indeed, this is a challenge for WFE members around the world.

ILS issuers have asked whether ESG reporting will be compulsory for insurance-linked vehicles like catastrophe bonds. The ESG aspects of the BSX Draft Listing Guidance is not intended to be compulsory. We understand investors are asking more questions about cat bond instruments and how they contribute to achieving and safeguarding sustainability. We believe it may benefit sponsors of cat bonds to better respond to the information needs of ESG-oriented investors.

In the WFE’s 2018 Sustainability Report, almost 80 percent of exchanges carried out ESG disclosure in markets where reporting is encouraged or required. Clearly, reporting according to standardised criteria will be a big benefit to investors, exchanges and listed issuers.

At the BSX, we believe sustainability is definitely becoming more mainstream in the world of finance following the growing focus on these issues by policymakers and businesses alike.

This involves promoting the increase of insurance vehicles that contribute to the mitigation of, and/or adaptation to, climate change as well as social challenges globally.

It has been recognised that there is a market of other sustainability-themed bonds, including those linked to the UN SDGs. Developments in international policy over the last few years have brought about a momentum within the global capital markets to establish a link between investments and achieving the SDGs.

Some of the world’s biggest companies in insurance and reinsurance are well along this path and certainly we have seen Bermuda companies bolstering their offices of corporate social responsibility.

Are the companies issuing and structuring ILS adjusting?

The ILS market is fluid and adaptable. While initial structures were focused on natural catastrophe and weather risk, a range of coverages, geographies and triggers are now being written. Finding ways to transfer risk is important to the fiscal sustainability of public entities, citizens and businesses in order to increase resilience to natural disasters and severe weather.

Forward-thinking ILS fund managers, hedge funds and asset managers based in Bermuda embraced ESG a long time ago; they have cemented credentials, have impressive track records and remain committed to a high-impact sustainable agenda.

We have seen concerted efforts from both the private and the public sectors to push forward ESG initiatives with the objective of ensuring more sustainable business practices and enabling the transition to a more sustainable economic and financial system.

It is increasingly the hot topic of conversation at financial conferences around the world and will only increase in importance.

Our embracing of ESG at the BSX has already led to conversations that are opening doors to new markets with the goal of tackling pressing issues and making a real and tangible difference in the lives of people in all corners of the world.

Might this represent an additional boost for ILS?

Bermuda is known as a centre of excellence for good reason—we have a great mix of concentrated intellectual capital, a responsive and responsible regulator, and access to markets worldwide.

The Island has been a trusted incubator for financial instruments that have helped investors, shareholders, governments and firms around the world manage their risks securely and cost-effectively for more than 70 years. The BSX looks forward to continuing its contribution to the real global economy and driving innovation behind the ESG agenda in Bermuda and around the world.

For example, Bermuda-based Nephila Capital is the oldest and largest investment manager specialising in reinsurance risk. Nephila offers a broad range of investment products focusing on instruments such as ILS, catastrophe bonds, insurance swaps, and weather derivatives.

In June, Nephila Climate issued a special report: Using risk transfer to achieve climate change resilience. The report concludes that: “As climate change drives more interest in mitigating and hedging growing risk exposure, and as word gets out how industries like electric power, agriculture, and renewable energy have hedged weather risks in a productive way for over a decade, it is a reasonable hope and expectation that Weather Risk Transfer and catastrophe coverage can be successfully and cost-effectively used for climate change adaptation by a wide range of public and private organisations.”

Who else is interested in ESG?

The BSX is also working to educate our stakeholders—our member companies, and our local population—on the importance of ESG and how it impacts their lives now and increasingly in the future.

We believe Bermuda is uniquely positioned to enhance dialogue on promoting sustainable products and services as a respected and dependable jurisdiction recognised for our corporate governance, solvency standards and effective regulation for the creation of innovative listed structures.

As the market evolves, and investors become more comfortable using ILS structures to mitigate risks, this market will only increase in its importance in offering protection against climate change-related natural catastrophes across the globe. We in Bermuda and at the BSX have embraced this appetite for investment in reinsurance and ILS.

What is clear is that the capital markets will have a hugely important role in mitigating climate change, improving the social conditions for billions of people around the world and demanding improved governance from corporations.

Greg Wojciechowski is the chief executive of the Bermuda Stock Exchange. He can be contacted at: gwojo@bsx.com