What Is Municipal Bond Insurance?

Bond insurance refers to the payment of a premium by a bond issuer to a professional insurance institution of a third party. The insurance company promises to repay the principal and interest on behalf of the bond issuer when it cannot repay the bonds agreed in the contract. Bond insurance is a financial insurance service provided by the bond insurer for the issuer of the bond. Once the bond issuer is unable to fulfill its repayment obligations, the bond insurer is responsible for paying off the remaining debt. The purpose of insurance services is to make bonds have the same high credit rating as bond insurers, thereby reducing the actual interest rate of bonds and lowering financing costs.

Bond insurance

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1. What is covered

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First, the basic situation of the development of U.S. bond insurance

In the 1970s, the issuance of bonds issued by companies, schools, hospitals and other institutions related to the local government in the United States gradually increased, but because there was no government guarantee, the issue cost was higher. Issuers want to use external credit enhancement methods to improve credit ratings and reduce issuance costs. Bond insurance, the main means of credit enhancement, came into being. Since then, the application of bond insurance has further expanded to structured financial products. And played an important role in the development of the US bond market. In 2006, U.S. bond insurers provided credit enhancement for 48.2% of newly issued municipal bonds, accounting for more than 50% of structured financial product credit enhancement measures. In addition, in the European and Japanese bond markets, some bond issuers have achieved credit enhancement through the purchase of Credit Default Swaps (CDS), which has also become a common method.

Bond insurance means that when a bond is issued or traded, the insurer (bond issuer or investor) insures the bond insurer (professional bond insurance company or other financial institution). The insured bond often gets the same credit rating as the bond insurer. ; If the bond issuer fails to repay the principal and interest in a timely manner, the bond insurer will guarantee the unconditional and full payment of losses caused by various types of risks. There are two specific forms of bond insurance: the insurer signs an insurance agreement with the bond insurer, or purchases the CDS it sells. In practice, the main form of bond insurance is CDS sold by bond issuers who buy professional bond insurance companies.

The rapid development of bond insurance in the United States is mainly due to the following reasons: First, the main bond insurers can raise funds through channels such as listing, with sufficient capital and good profitability, so they generally receive the highest credit ratings; and second, the market There are rating agencies with strong credibility, such as S & P, Moody's, and Fitch. The results of the ratings provide important reference for bond insurers to determine premiums. Third, the credit market in the bond market is rich and clear, and the corresponding risk premium is reasonable. The insurer has laid a solid foundation for the reasonable determination of the insurance premium rate. The fourth is that a large number of municipal bonds have been issued in the United States. At the same time, American financial institutions have vigorously developed personal housing mortgage loans and related structured financial products such as ABS and MBS. Cost, the market demand of relevant issuers for credit enhancement has increased rapidly.

After the subprime crisis broke out, the default risk of structured financial products insured by American bond insurers increased, leading to increased claims and substantial losses, and credit ratings were downgraded. At present, regulators and bond insurers are seeking to control losses and relegation through measures such as capital injection, spin-off of municipal bond business and structured financial product business, and settlement of high-risk structured financial product business. In Britain, France, Germany and other countries, the bond insurance market is relatively stable because there are fewer high-risk bonds insured and no large-scale defaults have occurred.

Second, the introduction of bond insurance in China will help promote the healthy development of the bond market

Launching bond insurance in China's bond market can promote the development of China's bond market in the following three aspects.

(I) Promote the development and improvement of the credit rating mechanism of China's bond market

China's credit rating industry is still in its early stages of development, and a reasonable credit rating mechanism has not yet been formed. Bond insurance institutions provide insurance for bonds, and must also evaluate the possibility of default by the insured. Compared with rating agencies, bond insurance institutions must compensate for bond defaults. From the perspective of US practice, bond insurance institutions have higher premium rates. It can truly reflect the credit risk of bonds. The introduction of bond insurance in our country allows agencies with rating capabilities to provide insurance for bonds based on their ratings of corporate credit bonds, enabling mutual verification between different rating methods and rating mechanisms to provide the market with differentiated credit ratings Effective means and methods, and can promote the comparison and reference between rating agencies to further improve the rating method and rating mechanism.

(2) Provide market-oriented credit enhancement methods for the development of corporate credit bonds in China

Prior to October 2007, most of China's corporate credit bonds were guaranteed by commercial banks for credit enhancement. However, there are major administrative intervention factors in the use of this credit enhancement method. The first is the combination of administrative approval and compulsory guarantees. In addition, commercial banks have a large business dependence on enterprise groups, and enterprise groups can use their market forces. Affecting the pricing of guarantees, the rate at which commercial banks guarantee corporate credit bonds often does not reach their due risk premium, resulting in unequal risks and returns. Second, guarantees are concentrated in state-owned commercial banks, hindering the development of other market incentive and restraint mechanisms. After the bond guarantee, the credit rating is actually an assessment of the guarantor's credit. In practice, investors generally believe that state-owned commercial banks will not be at risk of failure, and therefore ignore the role of credit ratings and information disclosure. The successful experience of domestic and foreign bond market development shows that a complete market incentive and restraint mechanism such as information disclosure and credit rating is a solid foundation for the development of corporate credit bonds. Therefore, years of compulsory guarantees have failed to promote the development of corporate credit bonds. It is precisely because of the inherent shortcomings in these two aspects of this guarantee method that the relevant authorities in October 2007 requested that commercial banks no longer engage in this type of business and gradually withdrew from the past corporate credit bond guarantee business.

The outbreak of the subprime mortgage crisis has caused the US bond insurance industry to face difficulties, but it cannot negate the promotion of market-based credit enhancement methods to the development of US corporate credit bonds. From the development history of the US bond market, the development of the fixed income product market has also been accompanied by the simultaneous development of market credit enhancement methods, including bond insurance. The development of the bond insurance industry today has its twists and turns, mainly due to the bond insurance industry's own Weakened risk awareness, vicious competition and weak supervision. Therefore, the development of China's bond market still requires market-based credit enhancement methods.

(3) Promote the stable development of China's bond market

Because risk management and risk tolerance are different, investors have different preferences for risk. The development of bond insurance can allow risk-preferred investors with risk management and affordability to provide higher security by providing insurance for bonds, and allow risk-averse investors to surrender risks and obtain fixed income. Achieving a reasonable allocation of risks, diversifying, transferring and trading risks among market entities with different risk appetites and tolerances, to achieve a balanced allocation of overall risks, is conducive to the stable development of the bond market.

Third, China's introduction of bond insurance is feasible

From the practice of the United States, bond insurance can be realized through two methods of financial guarantee and credit default swap. At present, the introduction of bond insurance in China has certain feasibility in terms of law and market conditions.

(I) Bond insurance can be carried out under the current legal framework

First, under the current legal framework, bond insurance can be developed through guarantees. Article 2 of the Guarantee Law stipulates that, in the economic activities such as lending, trading, cargo transportation, processing contract, etc., where creditors need to guarantee the realization of their creditor's rights by means of guarantee, a guarantee can be established in accordance with the provisions of this law. The guarantee method can be divided into guarantees Article 6, mortgage, pledge, lien and deposit; Article 6 stipulates that guarantee refers to the agreement between the guarantor and the creditor that when the debtor fails to perform the debt, the guarantor performs the obligation or assumes responsibility in accordance with the agreement; Article 21 provides for the scope of the guarantee. Including the main creditor's right and interest, liquidated damages, damages and the cost of realizing the creditor's right; Article 22 provides that, during the guarantee period, if the creditor transfers the creditor's right to one person in accordance with the law, the guarantor will continue to assume the guarantee responsibility within the scope of the original guarantee. Bonds need to be repaid with principal and interest, and have the characteristics of borrowing. The above provisions of the Guarantee Law provide a legal basis for the bonds to obtain guarantees and guarantees throughout the lifetime.

Second, the current law does not prohibit CDS transactions. At present, China's financial market as a whole is in a new period of encouraging innovation and development, and relevant laws have not prohibited investors from trading in financial derivatives. Commercial banks, securities companies, and insurance companies have all participated in the trading and market-making of financial derivative products such as bond forwards and interest rate swaps; enterprises have also extensively participated in the trading of financial derivative products such as bond forwards and interest rate swaps. CDS is a financial derivative product, and related laws have not prohibited its transactions.

(II) China has begun to regulate market conditions for the development of bond insurance

As far as the current market environment in China is concerned, firstly, corporate credit bonds have gradually shifted from the administrative examination and approval system to the review and approval system, and the competent authorities have no longer mandated the provision of guarantees and gradually restored their credit characteristics. Because corporate bonds have certain credit risks, there is a market demand for credit enhancement methods such as bond insurance. Second, through the standardized development over the past few years, investors in the bond market have gradually deepened their understanding of credit ratings. China's bond market has formed a credit rating agency with a certain credibility, and the market has a certain degree of recognition for its rating results. Third, after years of development, participants in China's bond market have initially acquired the ability to price bonds. Fourth, with the development of China's stock market, it is possible for bond insurance companies to raise funds for listing.

4. Considerations about launching bond insurance in China

(I) Options for developing bond insurance business in China

In summary, we can consider developing bond insurance in China to create conditions for the healthy and rapid development of the bond market. There are currently three ways to advance this work.

The first is to promote insurance companies to launch bond insurance business. Because the bond market has a higher credit rating of financial institutions than non-financial institutions, and financial institutions also have advantages in information and risk management, financial institutions are preferred to develop bond insurance business. Among the financial institutions, due to the aforementioned reasons that the banking industry is greatly affected by corporate groups and lack of actuarial talents, coupled with the regulatory authorities have explicitly prohibited it from providing guarantees for corporate credit bonds, commercial banks should not provide credit for corporate credit. Bonds provide insurance. Because securities companies have small assets and are affected by the fluctuations of the Chinese stock market, their ability to withstand risks is relatively weak, and it is not appropriate to provide bond insurance. Insurance companies have strong risk management capabilities and high market recognition. In the long-term insurance business, they have accumulated rich actuarial and other risk measurement and management experience. According to the "Insurance Law", property insurance business includes "liability insurance, credit insurance, etc." Insurance business ", under which insurance companies can provide insurance for the credit of bond issuers. Therefore, among existing institutions, insurance companies are the most suitable for carrying out bond insurance business.

The second is to launch CDS products in the interbank market. After years of development, the interbank bond market is relatively complete in terms of infrastructure, investors, external supervision and legal systems, and market self-discipline. The China Interbank Market Finance Association launched the "China Interbank Market Finance" in March 2009. The Derivative Product Transaction Master Agreement (2009 Edition) "provides the necessary conditions for the development of CDS, and only requires the consent of the relevant regulatory authorities to carry out such business.

The third is to set up special bond insurance institutions. According to Article 7 of the Guarantee Law, a legal person, other organization, or a citizen who has the ability to pay on its behalf may act as a guarantor. Therefore, a special bond insurance institution may be established accordingly. Bond insurance institutions can be established as limited liability companies, jointly funded by large financial institutions and large enterprise groups. The scope of business includes not only bond insurance, but also consulting, management, and personnel training services for bond issuers and investors. In terms of governance structure, we can learn from the experience of the United States. The company sets up a shareholders' meeting as the highest authority of the bond insurance institution, and has specialized committees such as the risk or credit management committee, compensation committee, and audit committee. Administrative departments can set up Guarantee department, CDS transaction department, information consulting department, legal department and other departments.

Because bond insurance institutions generally require the highest credit ratings, the guarantees provided by them can be recognized by the market. Therefore, the main advantage of setting up a bond insurance institution is that the parent company can support it to obtain the highest credit rating. Support methods include providing guarantees, or signing "well-run" agreements, promising to help them maintain a certain level of credit. At the same time, large financial institutions and enterprise groups, including insurance companies, have strong risk measurement and management capabilities, and can provide effective business guidance to bond insurance institutions as their subsidiaries.

Comparing the above three options, if we want to promote the development of bond insurance business in China as soon as possible, we can allow existing qualified insurance companies to start bond insurance business or launch CDS in the interbank market. But in the long run, in order to reflect the advantages of professional operation of credit enhancement business and better adapt to market development, we should start to set up a special bond insurance institution. At the same time, considering that bond insurance institutions need to have a high credit rating, it is recommended that the funder should have a national background. Considering the participation of national large enterprise groups or financial institutions, and forming a good corporate governance structure.

(II) Attention should be paid to risk prevention after the development of bond insurance business

Bond insurance business provides guarantees for bonds, which is an important risk pricing and transfer link in the bond market. Therefore, the establishment of a sound bond insurance system can provide credit enhancement for credit bonds and promote the development of the bond market. An imperfect bond insurance system may It will disrupt the market's risk pricing information and trigger systemic risks in the bond market. Judging from the development process of the US bond insurance, there are two main reasons for the incompleteness of the bond insurance system. The first is the excessive competition in the bond insurance industry and the weakened risk awareness of bond insurance companies under the loose macroeconomic policy environment, leading to the entire industry The decline in insurance rates has weakened the solvency of bond insurance companies. The second is the lack of an effective regulatory system for the bond insurance industry. After credit rating agencies and other market members proposed that bond insurance rates were too low, which would affect the bond insurers' ability to pay. The regulatory authorities failed to take timely measures to improve the solvency of the bond insurance industry. Therefore, after the development of the bond insurance business, two aspects can be considered to strengthen risk prevention. The first is to conduct prudential supervision of bond insurance companies with the core of compensability. The main contents include capital adequacy ratio and provision coverage ratio. It is required that bond insurance companies implement reinsurance on the insured bonds to restrict the high-risk expansion of bond insurance companies.