The Curious case of Pandemic Bonds

Welcome to Finance and Fury, The Furious Friday edition

You probably are exhausted about the coronavirus – What you probably haven’t heard about is A little known type of bond created in 2017 by the World Bank.

1. The World Bank – Headquartered in Washington DC – back in June 2017 – issued Pandemic Emergency Financing Facility (PEF) – call them pandemic bonds
   1. Technically their debt/lending arm – the International Bank for Reconstruction and Development
   2. Facility created by the World Bank to channel surge funding to developing countries facing the risk of a pandemic
      1. Is an international organisation created in 1944 – part of the Brenton woods era of creation of agencies
   3. The World Bank has two main goals: to end extreme poverty and promote shared prosperity – does this primarily by providing loans to its borrowing member government clients in middle-income countries
   4. Loans in the form of bonds – done so through the international capital markets for 70 years to fund its activities
2. 2017 – the World Bank issued $425 million in a new type of “pandemic bonds” – Marks the first time that the World Bank is in the business of infectious diseases – with a maturity in just a few months – July 2020
   1. Was oversubscribed by 200% – with investors eager to get their hands on the high-yield returns on offer
   2. World Bank Group President Jim Yong Kim said. “We are moving away from the cycle of panic and neglect that has characterised so much of our approach to pandemics. We are leveraging our capital market expertise, our deep understanding of the health sector, our experience overcoming development challenges, and our strong relationships with donors and the insurance industry to serve the world’s poorest people. This creates an entirely new market for pandemic risk insurance. I especially want to thank the World Health Organisation and the governments of Japan and Germany for their support in launching this new mechanism.”
3. How does it work – Investors buy the bonds and receive regular coupons payments in return but if there is an outbreak of disease, the investors don’t get their initial money back
   1. PEF financing to eligible countries will be triggered when an outbreak reaches predetermined levels of contagion, including number of deaths; the speed of the spread of the disease; and whether the disease crosses international borders. The determinations for the trigger are made based on data as reported by the World Health Organisation (WHO)
4. There are two varieties of debt, both scheduled to mature in July 2020.
   1. First bond raised $225 million – coupon rate of around 7% p.a. Payout on the bond is suspended if there is an outbreak of new influenza viruses or coronavirus (SARS, MERS).
   2. The second, riskier bond raised $95 million at an interest rate of more than 11%. This bond keeps investors’ money if there is an outbreak of Filovirus, Coronavirus, Lassa Fever, Rift Valley Fever, and/or Crimean Congo Hemorrhagic Fever.
   3. The World Bank also issued$105 million in swap derivatives that work in a similar way to protect the losses
   4. Done to attract a wider, more diverse set of investors – as it minimises the loses
5. Countries eligible for financing under the PEF’s insurance window are members of the International Development Association (IDA) – an arm of the World Bank Group that provides finance for the world’s poorest countries
   1. The PEF, under its insurance window, has the capacity to provide payments up to a maximum of US$ 425 million during its initial 3-year period for all qualifying outbreaks combined
   2. But the catch is that there are established ceilings of maximum payments for each of the disease families covered. The maximum payout per disease is capped at US$275 million for pandemic Flu, US$150 million for Filovirus – but US$195.83 million for Coronavirus – less than half of funds raised
6. Technical side to these bonds – in essence – are a combination of bonds and derivatives priced today (insurance window), along with a cash window, and future commitments from donor countries for additional coverage – convoluted and complex structure
7. What are these windows – The PEF has two windows.
   1. The first is an ‘insurance’ window with premiums funded by Japan and Germany, consisting of bonds and swaps including those executed today.
      1. The bonds and derivatives for the PEF’s ‘insurance’ window were developed by the World Bank Treasury in cooperation with leading reinsurance companies Swiss Re and Munich Re – Swiss Re Capital Markets is the sole book-runner for the transaction
      2. Swiss Re Capital Markets Limited, Munich Re and GC Securities were also joint arrangers on the derivatives transactions.
      3. The bonds will be issued under IBRD’s “capital at risk” program because investors bear the risk of losing part or all of their investment in the bond if an epidemic event triggers pay-outs to eligible countries covered under the PEF.
   2. The second is a ‘cash’ window, for which Germany provided initial funding of Euro 50 million. The cash window will be available from 2018 for the containment of diseases that may not be eligible for funding under the insurance window.

8. A pandemic has been called – The premiums bondholders have received thus far were largely funded by the governments of Japan and Germany, with some from Australian Aid – seems like the taxpayers have been covering the costs of this –
   1. Like the whole funding for the WHO behind the United States and United Kingdom -but yet Reports have claimed that most of the bondholders are firms and individuals based in Europe – so using tax funds to pay the investors in these bonds
   2. Claims that investors who purchased those products could lose millions – Who bought these? – Asset managers – about 16% – Pension funds about 42% of the risky bonds – but the derivative positions should cover most
      1. But the individual list of bondholders are not publicly available – just the types of funds
9. Market analysts and non-aligned economists have argued that these pandemic bonds were never intended to aid low-income pandemic-stricken countries – instead to enrich the financial sector
   1. American economic forecaster Martin Armstrong went on the record to call the World Bank’s pandemic bonds “a giant gamble in the global financial casino” – due to the derivative structures and counterparty risk – these bonds could present a structured derivative time bomb – all exploding at the same time the government controls around the pandemic are tanking markets   
   2. Armstrong went on to say that it is in WHO’s interest to declare the coronavirus outbreak a pandemic, but noted that, in doing so, they would cause bondholders to take a significant loss bottom of forms – but only if the derivatives don’t provide shift the risk to the counterparties
10. Irony of this scheme – – ineffective for doing anything to reduce an outbreak – or provide funding in a timely manner
    1. 1. These pandemic bonds fund created by the World Bank “to channel surge funding to developing countries facing the risk of a pandemic” and the creation of these so-called “pandemic bonds” was intended to transfer pandemic risk in low-income countries to global financial markets – remember this was the WHO who backed the World Bank’s initiative – as triggering a pandemic is in their authority
    2. Many policymakers have criticised the World Bank’s pandemic bonds – Under their provisions, the bonds haven’t yet made any payouts to threatened countries, because their terms require a waiting period of 12 weeks from when the triggering outbreak began
       1. Goes against what advocates said these pandemic bonds are meant to do. There was initially a belief that money would become rapidly available to countries early on in an outbreak
       2. If the goal was to stop a disease from spreading to new countries, then time was of the essence in setting a triggering event — and unnecessary delays are incredibly counterproductive.
    3. Critics, however, have called the unnecessarily convoluted system “World-Bank-enabled looting” that enriches intermediaries and investors instead of the funds intended targets, in this case, low-income countries struggling to fight a pandemic. These critics have asked why not merely give these funds to a body like the Contingency Fund for Emergencies at the World Health Organisation (WHO), where the funds could go directly to affected countries in need.
    4. Even Larry Summers, the former World Bank chief economist and the Secretary of the US Treasury who recommended sending garbage to poor countries dismissing the PEF as “financial goofiness.”
       1. The program was “designed to fail” because the bonds were crafted in order “to reduce the probability of payout but also limit the amount of funds to be paid out in an event to the derivative counterparties
       2. Current triggers guarantee that payouts will be too little because they kick in only after outbreaks grow large.

Summary 

1. It appears that All of this was created to enrich financial speculators rather than just providing funding for an outbreak
2. Anyway – Remember – the world bank ‘loans’ funds to third world nations – like all banks it isn’t a gift
   1. Gets these low-income nations in a position further indebtedness to the World Bank – denominated in USD
      1. So whilst the USD is surging right now due to the panic for people trying to get more of the reserve currency, the level of funds that have to be repaid grows
3. Problem with this – we just have to take their word on it – there is zero evidence they actually do what they say – and they are the ones saying they do this
   1. Who knows if the money gets paid out or if it goes towards helping reduce the spread – as others have said – it is too little too late.

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