World Bank's pandemic bond too little too late; needs to rethink structure
INVESTORS greeted the World Bank's first issuance of a pandemic bond in 2017 enthusiastically.
It marked the first time that World Bank bonds were used to finance efforts against infectious diseases. It was also the first time pandemic risk in low-income countries was transferred to capital markets. The issuance of bonds and swaps was oversubscribed by 200 per cent, and resulted in the risk transfer of US$425 million. Six viruses were covered, including coronaviruses. Coupon rates were also very attractive, more so in the current low-rate world. The higher-risk tranche paid 11 per cent and the lower-risk tranche 6.5 per cent, plus the six-month Libor ( London Inter-bank Offered Rate).
So, what was there not to like? Several things, as it turned out. The pandemic bond was patterned after catastrophe bonds, an established asset class. If the catastrophe to which an issuance is linked occurs, investors lose their capital; the bond is triggered and proceeds are disbursed to the country or party that is supposed to benefit. The Covid-19 outbreak was declared by the World Health Organization as a pandemic in mid-March when there were about 120,000 infections in 114 countries. The numbers have since exploded with over 2.6 million infections and more than 184,000 deaths.
Just last week, the bond's third party calculation agent declared that the bonds and swaps have indeed been triggered, ending weeks of speculation and hand wringing. Over US$195 million will now go to the World Bank's Pandemic Emergency Financing Facility, which will in turn distribute this to countries deemed the world's poorest by the International Development Association. There are 76 eligible countries, including Laos and Cambodia in Asia. But the outcome is seen by many as too little too late. The criteria for a trigger are based on a complex set of six conditions including the number of deaths, cross-border spread and an exponential growth rate of the disease in International Development Association countries.
By the time the boxes were ticked, time had been lost. The disease would have ravaged developing countries, which needed funds to mount an early response. In the meantime, the World Bank itself has disbursed funds more expeditiously. In March, it announced a US$14 billion package to help countries' Covid-19 response. It also said it was prepared to deploy up to US$160 billion over the next 15 months to "help countries respond to immediate health consequences of the pandemic and bolster economic recovery".
The widespread disillusionment with the pandemic bond is rooted in the inherent conflict of interest between profit-seeking investors and the bond's beneficiaries. The complex criteria to trigger a payout arguably makes it more profitable for investors, at the expense of poor countries. The structure also entailed a more generous payout for a flu pandemic, but less so for coronaviruses which were assumed to be less virulent based on past epidemics. Even so, investors were generously compensated by substantial coupon payouts, totalling over US$114 million, based on one calculation in mid-2019. These payments were funded by donor countries including Japan.
The World Bank is reportedly working on a new iteration of pandemic bond. It should rethink the structure. Making payout hurdles less onerous would make the bond less profitable for investors. That is a trade-off many institutions might be willing to make for the chance to do good.
