As Bermuda continues to adapt and evolve in order to maintain its status as a desirable re/insurance domicile, Fitch Ratings has said that although development of the market is broadly positive, recent regulatory activity related to the treatment of Tier 3 capital for re/insurers raises some questions.
Fitch notes that over the last ten years, the Bermuda Monetary Authority (BMA) has enacted more robust compliance and regulatory practices in an effort to promote more effective risk management processes and more conservative capital management standards.
Overall, the international financial services ratings agency views the steps taken by the BMA as broadly positive from both a policyholder and debt investor perspective, but warns that actions taken related to assignment of capital credit for some securities raises questions around conflicting language between debt offering documents and BMA’s Tier 3 regulatory requirements.
Specifically, Fitch explains that the BMA has approved Tier 3 regulatory capital credit for several companies’ recent and prior senior debt offerings, which, it says is “highly unusual”. This is because the failure to make scheduled interest payments or to repay principal at maturity result in default, where a missed interest payment without remedy would ultimately trigger an acceleration of principal repayment.
According to Fitch, firms that have issued unsecured senior notes that receive Tier 3 capital credit, as well as those firms that revised redemption language within terms of their previously issued unsecured senior notes to conform to the BMA’s capital requirements, includes: RenRe, Enstar Group, PartnerRe Finance B, Axis Specialty Finance, and Arch Capital Finance.
The ratings agency stresses that the securities approved for Tier 3 capital treatment have no provision to defer interest payments or principal repayment at maturity, even for a breach of solvency ratios. However, the BMA contends that firms must meet solvency ratios at all time, and as a result, Fitch says that “payments at maturity are de facto subject to redemption requirements.”
Fitch highlights the fact that in other domiciles, including the EU under its Solvency II regime, subordinated debt with interest deferral features is the typical instrument issued for Tier 3 regulatory purposes, adding that typically, neither interest deferral nor principal redemption deferral would result in a default.
“Positively, the BMA has indicated to Fitch that it has already initiated process changes that will remove any ambiguity between offering document language and Bermuda regulation with respect Tier 3 instruments that will be approved in the future by the BMA,” says Fitch.
The ratings agency also explains that, alongside restrictions on redemption at maturity, European Tier 3 instruments typically cannot be optionally redeemed before maturity if certain capital tests are not met, or without receipt of regulatory consent/non-objection.
Fitch notes that the BMA adopts similar capital tests based on its Economical Capital Requirement measure, adding that it does not view these restrictions on early redemption as non-performance risk.
“Fitch will continue to monitor the evolution of Bermuda’s regulatory capital regime whether securities issued are senior, subordinated or other hybrid debt, and how terms within indentures relating to priority, subordination, deferral and redemption features change over time, as per indications from the BMA that certain process changes have already begun. Any developments may influence future rating levels relative to outstanding debt as well as capital credit treatment in Fitch’s Prism model,” says Fitch.