Thierry Berthold, co-head of insurance and European structured credit solutions at Natixis in Paris, looks at what the next 12 months will have in store for the cat bond market

There is good reason to be optimistic for the catastrophe bond market in 2012, particularly in Europe. Asset managers are showing an increasing willingness to accept cat bonds as a viable asset class and the increase in new capital via dedicated ILS funds is likely to continue, as experienced in 2011.

This should maintain the virtuous circle, with more capital leading to more competitive pricing and therefore a higher level of issuance. Indeed, the European cat bond market is currently anticipating the arrival of new sponsors, taking advantage of competitive pricing levels and the increasing capacity for such risks.

This is not to suggest it will be plain sailing - cat bonds are a difficult asset class, carrying a particular risk-reward profile that requires time and experience to understand. But recent evidence suggests asset managers are showing a deepening appetite for this asset class.

Total issuance in 2011, following a number of new deals issued towards the end of the year, was US$4.3bn. The results of rigorous back-tests prove that cat bonds do offer truly uncorrelated risks - witness how well they have performed during the tumultuous past three years. This performance has not gone unnoticed among funds and investors looking for new exposures offering genuine diversification benefits.

ILS specialist funds are now succeeding in attracting new investors, such as pension funds and other institutional investors. Some multi-strategy hedge funds are coming back as well. One of the key questions for 2012 will be around the domination by a handful of ILS funds in terms of deal volume and the impact this will have on the market.

Meanwhile, we can also expect the issuance of more European-sponsored deals, which have traditionally represented a small proportion of the total market when including US deals. Indeed, specialist insurance-linked securities funds will be keen to seize the chance to increase their non-US catastrophe risk exposure.

PERILS, the catastrophe loss information provider, should continue to play an important role in stimulating the European cat bond market. The simpler risk transfer transactions that PERILS enables - considerably reducing documentation and transaction costs - and the good compromise it offers in terms of basis risk/acceptability by investors appeals to existing and new sponsors alike, particularly via private transactions. Second tier insurance companies and bonds hedging against new risk types should emerge - including flood risk in the UK - following new loss data sets introduced by PERILS.

Of course, all this must be considered in the context of the traditional reinsurance market. The virtuous circle scenario mentioned above clearly helps improve the competitiveness of current cat bond spreads and is attractive for sponsors.