Investing with impact

Green catastrophe bonds aim to reinvent the world of impact investment by delivering a return for both the planet and investors. As delegates gather for this week’s Cop26 climate talks in Glasgow, here’s why professional services firm Aon are hoping green cat-bonds signal a new dawn for innovative finance… 

“Bond will save the world!” is an epithet many of us have become accustomed to seeing and hearing in recent weeks: splashed across billboards, in No Time to Die film reviews, or even uttered by Liverpool manager Jürgen Klopp during press conferences. But, if there is to be a saviour of global problems, particularly the ongoing horrors of the climate crisis, it’s arguably not going to be a fictional, Martini-swilling, philandering spy-gone-rogue that does it. Instead, it could be a different Bond, a green cat bond. 

Green cat bonds – or green catastrophe bonds, to give them their non-abbreviated moniker – are an innovative financing solution that could be a game-changer in the fight against global warming. A more sustainability-focused version of the catastrophe bond (see below), green cat bonds are increasingly being embraced by purpose-led investors and corporations. By mobilising funds towards sustainable projects (for example resilient infrastructure or wildfire prevention), they can deliver a return not just for the planet, but investors too. 

As delegates discuss new sustainable finance models at this week’s Cop26 climate summit in Glasgow, green cat bonds could be high on the agenda. As Paul Schultz, CEO, Aon Securities, explains, there’s currently a lot of buzz surrounding them: “The combination of green cat bonds and the push towards ESG-focused investing will create a framework that enables a much more rapid and sustainable growth than through cat bonds alone. ESG and green cat bonds are in the early stages of a journey together; it’s an exciting place to be…”

What is a catastrophe bond? 

Catastrophe bonds emerged in the 1990s after a spate of disasters in the US, including 1992’s Hurricane Andrew and the 1994 Northridge earthquake. Also known as cat bonds, they are often issued through investment banks and sold to investors, before being triggered whenever a major catastrophe happens. This scenario would see a loss for the investors, but the cat bond funds would be disbursed quickly by the sponsor (insurance company, government, or corporation) to help aid recovery efforts. It can be a great help especially given many natural tragedies incur damages which are either uninsured or not covered by invested premiums. 

What’s in it for the investors? Well, if the catastrophe doesn’t happen, or can be averted, within the time period set by insurers (usually three years), then the investors get their money back – with interest. This means they make a positive return on their investment. 

It also gives the investors an incentive to create greater resilience for their interests (such as reinforcing their Caribbean resort with hurricane-proof concrete). 

Mexico has used cat bonds to hedge earthquake risk since 2006, while millions of pounds worth of cat bonds were triggered by the Japanese tsunami and earthquake five years later. Cat bonds have also been used by the World Bank for cyclone/earthquake risks in Caribbean countries. They’re also being used by the Danish Red Cross, who issued the world’s first volcano cat-fund earlier this year. Should any of the 10 volcanoes covered by the bond erupt in the next five years, then up to $3m (£2.1m) of funds would be released immediately. 

Today, Aon Securities estimates all collateralized (re)insurance assets, including cat bonds, to be a $100bn (£72bn) market. This year has seen more cat bonds issued than any other year in history. A growing number of corporations and investors are harnessing cat bonds too, many using it for risk transfer (in fact, $1.6bn/£1.1bn of corporate risk was transferred to the capital markets from 2018 to 2021). 

What are green catastrophe bonds and how are they different? 

Put simply, green cat bonds are a new classification of cat-bond giving investors – particularly those interested in ESG and purpose-led initiatives – assurance their invested funds will be use in sustainable ways. Or, as Schultz puts it, “A green cat bond is a nice starting place for a cat bond to follow an ESG or green strategy.” 

Cat bonds have to meet certain criteria if they are to achieve its “green” prefix, according to Schultz, including “ensuring the collateral is invested in an ESG-compliant strategy” (so no corrupt dictatorships or companies with links, for example, to Arctic drilling). 

Why are cat funds so attractive to investors and corporations? 

So far, nearly all direct cat bond investors have been institutional investors, who have purchased them through hedge funds, asset managers and investment advisers. The recent appetite shown by investors for green cat bonds aligns with their ESG and purpose-led objectives, which influence the portfolios they choose to invest in. For corporations, green cat bonds may help them meet their UN sustainability development goals (SDGs).  

As long as they’re not triggered by an adverse event, cat bonds are also a high-yield opportunity for investors, generally paying higher interest rates than comparably-rated alternatives. 

“Investors find the proposition of green cat bonds interesting because the asset class [of green cat bonds] behaves differently to other assets like equities or fixed income,” says Schultz. “An investor will say to the cat bond sponsor, “As long as you pay me a certain premium which I think is a fair premium for the risk I’m taking, I’ll expose my capital to that potential catastrophe’… If that event doesn’t happen, I’ll get my capital back with interest. And if it does happen, then it’ll help with the recovery.”

How can green cat bonds help corporations/investors with their ESG commitments? 

“Green cat bonds and ESG are a natural fit, says Schultz. “Part of ESG is resilience.” Take the example of an investor using a green cat bond to invest in reinforcing dams in an area of south-east Asia susceptible to typhoons. Not only does this create more jobs in the local community, the green cat bond can also prevent a significant human toll should a typhoon strike and cause flooding. If for whatever misfortunate reason, the dams aren’t strong enough and local homes are damaged, then the green cat bond would be triggered, releasing capital quickly to help those afflicted by the floods. The investor may not see a return on their investment, but local communities will benefit, plus it will encourage more investment in reinforcing the dam infrastructure. It creates a virtuous circle which Schultz describes as “promoting resiliency at the same time you’re promoting the recovery aspect… The more you can do to create resilience at a time when there’s a fair amount of volatility in the world, the better.”

Aon has previously helped develop cat bonds for Mexico, Jamaica, Colombia and Peru where it has helped offer protection against earthquake risk. Elsewhere, green cat bonds could help rehabilitate destroyed land and restore biodiversity after droughts or heavy rainfalls. 

What will happen with green cat bonds at Cop26?

“We’re hopeful green cat bonds will be on the agenda,” says Schultz. “But what we want is education: let’s make sure as many people as possible understand what this opportunity represents. It’s early days and this will take time to develop into a robust framework. But it all starts with excitement, awareness and education… There isn’t a week that goes by where we don’t try to move the needle a little bit forward on this.”