Catastrophe bonds are having a ball. The €50bn market—structured notes that pay handsomely unless wind or fire destroy insured assets—has grown so fast that retail money now holds almost a third of outstanding deals. Not so fast, regulators say — sparking a backlash.
Last June the European Securities and Markets Authority (ESMA) told the European Commission to tighten the rules that decide which assets can sit inside UCITS. (Undertakings for Collective Investment in Transferable Securities is a €12.6tn regulatory framework governing mutual funds, ensuring they are safe, liquid, and easily marketed to retail investors across Europe. These funds focus on diversification, liquidity, and high investor protection standards.)
John Seo, co-founder and managing director of Fermat Capital Management, the $11bn hedge-fund manager that dominates the niche, spies official unease. “We’ve been heavily involved in the industry responses and coordinated with our peers in the industry to consolidate our stance,” he said in an interview. So “we’ve been very actively involved in all this.”
Insurers’ orphan
ESMA’s final report demands a mandatory look-through test for 90 per cent of every UCITS portfolio. Direct holdings of alternative assets—commodities, crypto-assets and catastrophe bonds among them—would stay ineligible. Indirect exposure could lurk only inside the existing 10 per cent ‘trash bucket’. Anything above that “would risk blurring the lines with alternative investmen funds”.
Alternative Investment Fund is a collective investment vehicle that pools capital from investors to invest in non-traditional assets—such as hedge funds, private equity, real estate, or commodities—which do not fall under standard UCITS regulations. Officials insist the cap targets complexity, not one product. “More than ten per cent of cat bonds in UCITS risks turning UCITS into a quasi-AIF,” said Kian Navid, senior policy officer at the watchdog.
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Money managers call the idea heavy-handed. “This is frankly an unprecedented thing, if it were to occur,” Mr Seo told Financial Times. Cat bonds returned 55 per cent over the past four years, matching equities while dodging the tantrums that sank high-yield credit. The instruments help insurers lay off climate-driven risks and give savers a rare slice of uncorrelated yield. Yet ESMA worries about event-driven payouts that depend on opaque catastrophe models, dealer-driven trading that can vanish when storms brew, and information gaps that trip MiFID II suitability tests.
Policy-makers share the misgivings. Mr Navid said, “But their valuation can be more challenging, and the liquidity profile is also different than that of stocks or traditional bonds.” He added that regulators will do what they can to move forward in a way that avoids unsettling the market, noting that most cat-bond fund managers typically pitch the products to professional investors.
Battle lines at the Berlaymont
The Commission has not yet drafted a law. Its 2026 work-programme de-prioritises a full rewrite of the eligible-assets directive but flags a consultation later this year. Market watchers expect a decision by late 2026 because ESMA’s advice is already on the table. Mr Navid sought to calm nerves, saying the goal is to avoid a sudden disruption so that asset managers “wouldn’t have to liquidate existing funds or make portfolio recalibrations,” and he also noted that “the practical implications are low,” due to the very small size of UCITS cat bond funds relative to the wider UCITS market.
Managers doubt that. If Brussels slams the door, Fermat reckons €15-18 bn of retail-held cat bonds would need new homes, a hefty chunk of global supply. Some peers lobby for a “liquid alternative” wrapper—stricter than UCITS, looser than an alternative-investment fund—rather than a blanket curb.
The good thing about the European approach to these issues is that it’s very gradualist. — John Seo, Fermat Capital Management
Investors themselves appear relaxed. Mr Seo said, “it may sound scary talking about catastrophe bonds” just because the “very term itself” conjures up catastrophic scenarios. “But the actual risk is among the most transparent and easy to understand for the end investor,” he said. “So there’s no mystery to it.”
Follow the money
The hedge-fund veteran thinks regulation lags sentiment. “Our perception is that there’s tremendous resistance to this proposal from the investors themselves,” he said. “In other words, if you really are talking to the investors, what they will say is that this seems to be almost a case where the top level regulatory authorities are less comfortable with the asset class than the investors themselves.”
He forecasts work-arounds. “When there’s a genuine interest in and demand from an investor pool, they will find a way to invest,” he said. For now, no one at Fermat is hitting the sell button. “The good thing about the European approach to these issues is that it’s very gradualist,” Mr Seo said.
Managers nevertheless hedge their bets. Funds above the 10 per cent threshold model forced sales, bolster MiFID II disclosures and rehearse migrations into AIF or ELTIF structures. ESMA discourages grandfathering but hints at a long transition to avoid cliff-edge stress.
Risk and reward
Supporters of the cap say it protects gullible savers from black-box maths and thin markets. It may also shore up faith in the UCITS badge after recent mis-selling scandals. Critics reply that Brussels would shove retail cash towards longer-duration corporates or racier credit, raising portfolio risk instead of dampening it. Retail investors would also lose a stake in climate-protection finance at a time when insurers crave capital.
Cat-bond issuers fear liquidity shocks if hordes of small holders exit at once. Yet regulators note that UCITS money remains a minority. The test will come if the Commission endorses ESMA’s view and the Parliament and Council nod it through. The legislative grind could stretch into 2028, leaving plenty of time for lobbying and, perhaps, compromise.
