Capital Market Transactions and Capital Markets Risk
The capital market transactions are made while trading in the capital market securities. Stocks and bonds are the two types of securities where the capital market investments are done. Capital market transactions are monitored by the financial regulatory bodies.
A typical capital market includes the trading of securities.
This is also the ideal market place for the companies and governments to raise funds. There are financial regulatory bodies in every country that monitor and regulate the capital market transactions in order to protect the investors from being cheated. U.S. Securities and Exchange Commission, Australian Securities and Investments Commission, Canadian Securities Administrators, Financial Services Authority (UK) and Securities and Exchange Board of India are some of the major financial regulators that regulate the capital market transactions in their respective countries.
The investment in the capital market can be done either in the new issues or in the existing securities. The primary capital market controls the new issue transactions while the secondary capital market takes care of the trading of the existing securities.
The corporations, banks or governments release stocks and bonds in the capital market in order to raise the long-term funds. The individual investors, companies, agencies and corporations can invest in these stocks and bonds either by purchasing or selling them. The trading of stocks and bonds in the capital is not easy for the novice and not even for the seasoned investors. It’s difficult to predict the trends of a capital market.
Every investor wants to play safe with their investments. There are financial advisers available to guide the investors telling them where to invest and where not to. There are stock brokers also who are experienced and eligible to guide people with stock and bond investments.
The capital market transactions are done by the brokers who are registered with the exchange to carry out the trading on behalf of their clients. Any individual cannot just walk in the stock exchange and invest on the stocks or bonds. He must have to go through the brokers in order to make any kind of transaction in the capital market.
The capital market risk usually defines the risk involved in the investments. The stark potential of experiencing losses following a fluctuation in security prices is the reason behind the capital market risk. The capital market risk cannot be diversified.
The capital market risk can also be referred to as the capital market systematic risk. While an individual is investing on a security, the risk and return cannot be separated. The risk is the integrated part of the investment. The higher the potential of return, the higher is the risk associated with it.
The examination of the involved in the capital market investment is the one of the prime aspects of investing. It can be easily said that the risk distinguishes an investment from the savings. The systematic risk is also common to the entire class of liabilities or assets.
Depending on the economic changes the value of investments can fall enormously. There may be some other financial events also impacting the investment markets. In order to give a check to the capital market risk, the asset allocation can be fruitful in some cases.
Any investment in stocks or bonds comes with the following types of risks:
- Market Risk
- Industry Risk
- Regulatory Risk
- Business Risk
The market risk defines the overall risk involved in thecapital market investments. Thestock marketrises and falls depending on a number of issues. The collective view of the investors to invest in a particular stock orbondplays a significant role in the stock market rise and fall. Even if the company is going through a bad phase, the stock price may go up due to a rising stock market. While conversely, the stock price may fall because the market is not steady even if the investor’s company is doing well. Hence, these are the market risks that the stocks investors generally face.
The industry risk affects all the companies of a certain industry. Hence the stocks within an industry fall under the industry risk. The regulatory risk may affect the investors if the investor’s company comes under the obligation of government implemented new regulations and laws. The business risk may affect the investors if the company goes through some convulsion depending on management, strategies, market share and labor force.
Cyber risk needs hybrid traditional & ILS reinsurance solutions: PwC
The massive exposures from cyber risk will eventually need to be dealt with by the insurance and reinsurance market with a hybrid approach, creating reinsurance products that leverage both traditional and capital market or ILS practices, according to PwC.
In a report released on 4 Sptember 2015 PwC discusses the enormous potential of the cyber insurance market, a market that the consultancy expects will grow to $5 billion in annual premiums by 2018 and at least $7.5 billion by the end of this decade.
The report, titled ‘Insurance 2020 & beyond: Reaping the dividends of cyber resilience‘ and announced at the Monte Carlo Reinsurance Rendezvous, reveals the huge exposure and potential costs associated with cyber risks and discusses the potential for the insurance, reinsurance and insurance-linked securities (ILS) market to develop products to help mitigate cyber risk exposures financially.
“Paul Delbridge, insurance partner at PwC, explained; “Given the high costs of coverage, the limits imposed, the tight terms and conditions and the restrictions on whether policyholders can claim, many policyholders are questioning whether their policies are delivering real value. There is also a real possibility that overly onerous terms and conditions could invite regulatory action or litigation against insurers.
“As Boards become increasingly focused on the need for safeguards against the most damaging cyber attacks, insurers will find their clients questioning how much real value is offered in their current policies. If insurers continue to simply rely on tight blanket policy restrictions and conservative pricing strategies to cushion the uncertainty, they are at serious risk of missing this rare market opportunity to secure high margins in a soft market. If the industry takes too long to innovate, there is a real risk that a disruptor will move in and corner the market with aggressive pricing and more favourable terms.”
The report addresses not just the opportunity presented by cyber risk, for underwriters with the skills and expertise to address the risk, but also how the market needs to respond in order to ensure the large amounts of capacity are there and how reinsurance capacity will be required to support cyber risk insurers.
One of the key recommendations is for hybrid risk transfer structures, capable of providing the risk capital required for such a massive exposure.
PwC notes that the cyber reinsurance market is currently less developed than the primary direct market for cyber risk, but says that as the understanding of the threats and maximum loss scenarios improves reinsurance firms could be encouraged to enter this market.
However PwC recommends that a hybrid approach is taken, between the traditional and alternative reinsurance markets, leveraging the best of the traditional reinsurance product where it is most suited and making use of the capital markets and ILS structures where they can play an important role.
“Risk transfer structures are likely to include traditional excess of loss reinsurance in the lower layers, with capital market structures being developed for peak losses,” PwC explains.
We’ve detailed this approach previously, that certain layers of the exposure are likely most suited to the ILS markets, if they can be parameterised and structured into transactions where the risk can be almost segregated to enable investors in the capital market to understand them.
PwC continues, saying; “Possible options might include indemnity or industry loss warranty structures, and/or some form of contingent capital.”
Certainly, once a cyber insurance market is established an industry loss warranty (ILW) product would be a great mechanism to enable the capital markets and ILS investors to take the top layers of exposure away from the traditional players.
Similarly, any other types of indices that could be created to enable cyber risk to be parameterised and better understood, could allow for capital market risk transfer structures to be used to transfer the peak risks to investors.
A natural development of this would be to see the risk securitized into catastrophe bonds, with an industry-loss or parametric index trigger. A modelled-loss trigger may also be possible, once the levels of data and exposure are better understood.
“Such capital market structures could prove appealing to investors looking for diversification and yield,” PwC notes.
If the risk is parameterised and understood to a degree that investors are happy to take it on, the diversification opportunity if clear. Cyber risk presents a true diversification for ILS investment managers, ILS funds and direct investors such as pension funds or family offices. As such any development of hybrid risk transfer using capital markets money would be an attractive prospect.
As most investors and ILS managers won’t have the experience in cyber risk necessary to understand and underwrite it, it will be vital that relationships are built with traditional insurance or reinsurance players, as well as with technology and cyber security providers.
PwC explains; “Fund managers and investment banks can bring in expertise from reinsurers and/or technology companies to develop appropriate evaluation techniques.”
One of the potential ways that a cyber cat bond or ILS solution could be seen to emerge is through partnership with cyber security firms. These firms understand their products, their clients and the penetration or hack-rate, meaning that if they choose to buy protection the data may be available to enable a capital market solution to be developed.
Cyber risk insurance is one line of business where ILS and the capital markets could potentially find itself directly providing risk transfer to corporates, particularly the very large cyber security technology providers of the world.
PwC highlights the need for a risk facilitator to emerge:
Given the ever more complex and uncertain loss drivers surrounding cyber risk, there is a growing need for coordinated risk management solutions that bring together a range of stakeholders, including corporations, insurance/reinsurance companies, capital markets and policymakers.
Some form of risk facilitator, possibly the broker, will be needed to bring the parties together and lead the development of effective solutions, including the standards for cyber insurance that many governments are keen to introduce.
The facilitator may come from the technology side, enabling the insurance, reinsurance and capital markets or ILS players to better understand the risks, the exposure, the potential magnitude of losses, making creation of these hybrid risk transfer structures more feasible in the future.
An interesting prospect for both the traditional re/insurance and ILS markets and one where cooperation, rather than competition, may be seen as vital as the cyber insurance market develops.