Treasury money market fund collateral

Treasury money market fund collateral is the investment of a cat bond's proceeds in money market funds holding US Treasury securities, kept in a trust account. The practice was born of a bankruptcy. In September 2008, the Lehman Brothers bankruptcy taught the cat bond market that a bond with no catastrophe could still lose money. Several deals had placed their collateral behind a total return swap with Lehman as counterparty. The swap guaranteed a floating rate and the principal value, and the assets behind it lost value just as the guarantor vanished. The four bonds involved, Ajax Re, Carillon, Newton Re and Willow Re, were downgraded by S&P (Standard & Poor's) and then fell into technical default on their interest payments. The market rewrote its structures over the following years. The proceeds now go into a trust account, in the name of the issuing vehicle and for the benefit of the cedent and the noteholders. That account is invested in government money market funds, which hold only US Treasury bills and repos backed by them. Directly held Treasuries also show up. When the cedent prefers a supranational name, the collateral takes the form of structured notes issued by the IBRD (International Bank for Reconstruction and Development) or the EBRD (European Bank for Reconstruction and Development). The money market fund reform the SEC (Securities and Exchange Commission) adopted in 2014 reinforced the choice: government funds keep a stable net asset value, with no mandatory redemption fees in stressed markets. The direct consequence for yield is that a cat bond's coupon is the sum of the risk spread and the collateral return. When US short rates climbed in 2022 and 2023, cat bond total returns rose with them, with no change in the catastrophe risk. What remains is exposure to the fund manager, the trustee and the asset substitution clauses, which investors now read line by line.