Fermat Criticizes ‘Unprecedented’ EU Plan to Limit Retail Investor Access to Cat Bonds
Fermat Capital Management says a European proposal to limit retail investors’ access to catastrophe bonds faces serious pushback, as money managers specialized in insurance-linked strategies mount a coordinated front.
John Seo, co-founder and managing director of the Connecticut-based hedge fund manager, says he’s been working with others in the industry to try to shield the market for cat bonds from the disruption he worries would follow such a regulatory intervention. He also says investors would ultimately find ways to work around stricter rules.
“We’ve been heavily involved in the industry responses and coordinated with our peers in the industry to consolidate our stance,” he said in an interview. So “we’ve been very actively involved in all this.”
Read more: Catastrophe Bonds Worth $17.5 Billion Land in EU Crosshairs
At issue is a proposal by the European Securities and Markets Authority that the European Commission limit the extent to which highly complex instruments such as cat bonds be included in UCITS, which is a fund category intended to protect retail investor interests. The recommendation, if acted on by the EU’s executive arm, would have major ramifications for the $60 billion market for cat bonds, of which UCITS funds currently account for almost a third.
“This is frankly an unprecedented thing, if it were to occur,” Seo said. Fermat, which has about $11 billion in assets, is the world’s biggest hedge fund manager focused on catastrophe bonds.
The extent to which retail investors should be exposed to complex, niche markets more broadly is a question that’s drawn renewed focus of late. Through exchange-traded funds and business development companies, for example, retail investors have increasingly been gaining access to markets that were traditionally the preserve of professionals.
In some cases, strains are emerging. In less liquid private market funds, there are examples of investors getting burned as financial firms impose caps on redemptions and even gate funds.
Seo says he’s aware that “it may sound scary talking about catastrophe bonds” just because the “very term itself” conjures up catastrophic scenarios.
“But the actual risk is among the most transparent and easy to understand for the end investor,” he said. “So there’s no mystery to it.”
The market for cat bonds has seen rapid growth in recent years as insurance firms look for ways to transfer mounting levels of risk from their books to the capital markets. The development is driven by rising urbanization, inflation and climate change, a cocktail of forces that’s making it costlier for insurers to provide coverage.
Cat bonds are structured so that investors risk losses if a natural disaster such as a hurricane strikes. At the same time, the bonds tend to be uncorrelated to geopolitical and economic disruptions. Over the past four years, cat bonds have outperformed high-yield bonds and broadly matched gains in major stock indexes, according to total-return data compiled by Bloomberg.
The market for UCITS, or Undertakings for Collective Investments in Transferable Securities, represents some €12.6 trillion ($14.4 trillion) in total assets under management. In June, ESMA advised the European Commission that cat bonds and similarly complex instruments may be better suited to alternative investment funds that don’t target retail investors. The commission has said its UCITS consultation process will continue in 2026.
A commission spokesperson didn’t respond to a request for comment.
ESMA’s UCITS recommendation follows a public consultation launched in 2024. Back then, Better Finance, the umbrella association representing retail investors in Europe, called for a conservative approach in determining what UCITS funds should be allowed to hold.
This month, ESMA warned of the “potential downside risks” associated with cat bonds, with reference to last year’s trigger event in Jamaica and the risk of investor losses tied to wildfires in Los Angeles. In its report, ESMA also pointed to the “heightened severity and frequency of natural catastrophes” as grounds for ensuring retail investors are adequately protected.
Seo says attempts to keep cat bonds out of UCITS funds would go against the wishes of investors that Fermat is in contact with.
“Our perception is that there’s tremendous resistance to this proposal from the investors themselves,” he said. “In other words, if you really are talking to the investors, what they will say is that this seems to be almost a case where the top level regulatory authorities are less comfortable with the asset class than the investors themselves.”
ESMA doesn’t want to “opine on whether cat bonds are a good or bad asset class,” said Kian Navid, senior policy officer at the watchdog. “But their valuation can be more challenging, and the liquidity profile is also different” than that of stocks or traditional bonds, he said in an interview with Bloomberg.
Regulators will do what they can to move forward in a way that avoids unsettling the market, Navid said, noting that most cat-bond fund managers typically pitch the products to professional investors.
The goal is to avoid a sudden disruption so that asset managers “wouldn’t have to liquidate existing funds or make portfolio recalibrations,” Navid said. He also noted that “the practical implications are low,” due to the very small size of UCITS cat bond funds relative to the wider UCITS market.
According to Seo, even if the EU opts to force cat bonds out of UCITS funds, retail investors will still find a way to hold the securities.
“When there’s a genuine interest in and demand from an investor pool, they will find a way to invest,” he said. And in the meantime, asset managers like Fermat don’t see any need to start winding down their cat-bond UCITS business, he said.
“The good thing about the European approach to these issues is that it’s very gradualist,” Seo said.
Top photograph: Homes surrounded by flood waters after Hurricane Beryl made landfall in Sargent, Texas, US, on Monday, July 8, 2024. Photo credit: Eddie Seal/Bloomberg