b'ILS and Convergence Markets Sidecars typically have a risk period of one year. Ifself-developed tail-to-tier approach was said to loss events occur during that period, funds are heldhave been designed to enable investors to capitalize in the trust account established for the cedingon the yield spread between catastrophe bonds and company prior to being released to the sidecarsubordinated bonds issued by European insurers.investors. In order to protect the ceding companyIn recognition of the growing importance to institu-from adverse loss development, most transactionstional investors of ILS funds, The Standards Board require that a buffer be established for the lossfor Alternative Investments (SBAI), a standards reserves, with such buffered amount held in thesetting body for the alternative investment industry, trust account. The buffered amount declines overannounced a series of projects relating to ILS funds, time until the reinsurance agreement is commuted.the first of which was a Toolbox Memo on valua-As a result of significant losses in 2018 and 2019,tion of ILS fund assets. In addition to standards of capital was trapped for much of 2020 (meaninggeneral applicability to hedge funds, the Toolbox that, while it would ultimately not be needed to payMemo focused on the need to address the particular claims, it was not immediately available to bechallenges posed by valuation in connection with a reinvested in other transactions). Large institutionalloss event pending receipt of claims data. investors, such as Canadian public pension funds, are continuing to allocate capital to ILS-dedicatedUntil recently, the issues around valuations following a funds, reflecting their appreciation that the assetloss event had been addressed by means of conven-class offers returns uncorrelated to the broadertional hedge fund technology used for illiquid or securities markets. This non-correlation began tohard-to-value investments. Affected investments were attract institutional investors in the aftermath of theplaced in side pockets, excluding them from the 2008 financial crisis, leading to significant growth ingeneral net asset value pool on which investor ILS fund assets under management since then.redemption proceeds and performance-based spon-Investor interest appears to have been spurred onsor compensation are calculated and excluding more recently by the anticipation of another end- incoming investors from participating in profits and of-cycle market downturn.losses on these investments. This practice eliminated A significant transaction in 2020 was the launch ofthe need to value the side pocketed assets. The loss Elevation Re by Premia Holdings Ltd., who becameevents of 2017 and 2018 brought valuation following a the first runoff player to use a collateralized reinsur- loss event into sharp focus Investors have particular ance sidecar vehicle to bring additional capital intoconcerns around the fact that investments were often its business. Recently, many runoff and legacynot marked down before being side pocketed, and in insurance and reinsurance companies have beenresponse sponsors began to explore alternatives to exploring the use of sidecar structures, seekingside pockets, often establishing reserves in excess of runoff and reinsurance opportunities with additionalGAAP reserves rather than removing the entire capacity from capital markets.investment from the asset pool. This addresses investor concerns and also allows for a more precisely A notable transaction in the ILS fund space was thecalibrated response to the loss event, which may not launch of the Plenum Insurance Capital Fund byalways affect the entire investment. The SBAI has Swiss-based ILS specialist and catastrophe bondannounced that its next Toolbox Memo in the series on investment manager, Plenum Investments AG. TheILS funds will address side pockets.MAYER BROWN 49'