Financial Instruments and Markets: A Casebook

9

Bank Leu's Prima Cat Bond Fund

In the summer of 2001, Matthias Weber, head of investment research and consulting at Bank Leu, knew he was onto a good thing; the question was how good. Since May 2001, Zürich-based Bank Leu had run a small but popular in-house fund, called the Prima Cat Bond Fund. The fund packaged so-called catastrophe bonds—“cat bonds”— which were sold exclusively to the bank's private clients. Cat bonds were securities whose coupon and principal payments depended on the probability of a catastrophe occurring, such as an earthquake or hurricane. It was traditionally large insurance and reinsurance companies that offered cat bonds, looking to transfer risk to the capital markets. The returns on the bonds were therefore completely tied to events covered by insurance policies.

It was clear to Weber that the asset class was new to both investors and issuers, with unclear regulatory treatment. Initially, all cat bond issues were underwritten as private placements, following the U.S. securities regulation Rule 144A. Although this permitted fewer filing requirements with the Securities and Exchange Commission (SEC), it prevented the cat bonds from being marketed to most individuals. In Switzerland, it was only recently that the country's Federal Tax Administration had determined the tax treatment of cat bonds. Still, individual investors could not invest in cat bonds except through a mutual fund—but to date, no such retail fund existed.

Therefore, Weber considered making ...