Not All SPVs Are Created Equal: Understanding Catastrophe Bond Collateralization

The Brookmont Catastrophic Bond ETF (ILS) is an actively managed ETF that seeks to provide investors exposure to the catastrophe bond market. Cat bonds have a unique structure compared to other, perhaps more widely-understood, traditional fixed income investments as they’re issued through Special Purpose Vehicles (SPVs).

An SPV is a legally distinct subsidiary entity created by an organization for a narrowly-defined, isolated purpose. Generally speaking, the purpose of an SPV is to hold a specific group of assets.

SPVs are currently making headlines. Some Wall Street analysts are suggesting that SPVs being created by certain large companies might be an indication that the companies are nefariously moving liabilities off their balance sheets or pledging their collateral to multiple agreements in an effort to hide certain risks from their investors.

This is not the case with Cat Bonds. SPV’s bring bankruptcy remote, fully cash collateralized, well defined trigger mechanics and contractual clarity to the investor relationship. Additionally, unlike typical SPVs, Cat Bond SPVs are domiciled in jurisdictions like Bermuda, Cayman and Ireland with a strong regulatory environment specifically designed for reinsurance.

In cat bond transactions, an SPV operates as a legally separate entity so that, should the company sponsoring the bond face financial distress or insolvency, the collateral securing investor principal remains protected within the SPV. When investors purchase cat bonds issued by the SPV, their capital flows into collateral accounts where it remains segregated and secured throughout the bond's term.

This fundamental difference separates catastrophe bond investors from traditional corporate bondholders in a critical way: corporate bond investors face issuer credit risk where returns depend heavily on the financial health, operational performance, and creditworthiness of the issuing corporation. Investors in the ILS ETF, which owns cat bonds issued by these fully-collateralised SPVs, are exposed to natural disaster risk since a cat bond’s potential for principal loss will be determined by the occurrence of a specific, predefined catastrophic event. The SPV’s presence is specifically in place to limit investors’ unintended exposure to the issuer’s own financial health.

Sources:

Bain & Company

Reuters

Bloomberg

Octus

CPA Journal

The Journal of Accountancy

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