Pandemic Bonds Were Designed to Fail and They Just Did

Mish

Pandemic bonds issued by the World Bank in 2017 are on the verge of triggering.

Please consider Controversial Pandemic Bonds with Coronavirus Set to Trigger Payout.

In June 2017, the World Bank — the international financial institution that provides loans to poorer countries — sold around $425 million (€391 million) worth of bonds and derivatives aimed at providing financial support to developing countries facing the risk of a pandemic.

The less risky tranche of the bonds will not be paid back to investors if there are more than 2,500 deaths in developing countries as a result of a pandemic. Although China has recorded more than this number of deaths, the World Bank does not designate it a developing country.

By far the riskier of the two bonds is "Class B," which sold $95 million in bonds (compared to $225 million for the less risky "Class A," explained above). For Class B, if the disease crosses an international border and if there are at least 20 deaths in that second country, the investors' money will be paid to developing countries dealing with the outbreak.

I do not come up with $425 million total. $225 million plus $95 million does not total $425 million.

Only those class B bonds are going to trigger.

An international crisis is brewing. There are 19 deaths in Iran, 12 in Italy, and 12 in South Korea.

One more death in Iran is all it takes unless there are other restrictions.

Designed to Fail

Bodo Ellmers, the director of the Global Policy Forum's sustainable development finance program told the Financial Times the instrument was "useless."

"You obviously want to prevent a pandemic but it only pays out when it becomes a pandemic," he said.

Olga Jones, who worked as an economist at the World Bank for three decades, said it was absurd that discussions for a second round of bonds for what is known officially as the Pandemic Emergency Financing Facility (PEF) had begun, as they were effectively "designed to fail."

Many critics have also pointed to the fact that the severe attack of Ebola that hit the Democratic Republic of Congo in 2018 did not meet the conditions to trigger payment of the pandemic bonds despite the fact that almost 500 people died and that it was one of the largest outbreaks ever recorded.

Payout and Maturity

The Class A bonds feature an interest rate of 7% while the Class B bonds' rate is 11%.

According to the PEF, around $75.5 million had been paid to bondholders in the form of premiums as of August 2019. The full amount paid in interest and coupons has not been disclosed. The bonds are set to mature in July 2020.

Painful Problem

The Wall Street Journal discusses the Painful Problem With Pandemic Bonds

The idea behind pandemic bonds, issued by the World Bank in 2017, is simple: They pay investors a solid return, but if a pandemic breaks out, the principal is redirected to help low-income countries pay for their emergency response.

An investor who doesn’t do the legwork is liable to get burned when the bonds don’t behave as expected. At 386 pages, the prospectus for the World Bank’s class-B securities isn’t a light read.

The second and larger problem with pandemic bonds is one they don’t share with other catastrophe-related securities. During extreme events, they don’t offer a source of returns uncorrelated with major capital markets—one of the things buyers like most about the asset class.

Pandemic bonds are most likely to be triggered just as equities tumble and concerns about companies’ ability to finance themselves come to the fore, as now. In short, the asset class is uncorrelated with wider markets—except at the exact moment when that matters most. Then it is suddenly very correlated.

Questions Abound

These bonds pay interest. How does the Wold Bank pay that interest?

Generally, companies issue bonds for expansion and expect to pay the debt back from future profits or current income.

What is the World Bank invested in or doing with the money to pay way above market rates?

Only the $95 million in class B bonds will trigger. But at 11% interest with a maturity date coming up, most of that money has been paid out.

Even if some developing nations do end up receiving pandemic bond money, it will be a trivial sum when compared with the economic damage from a sustained coronavirus pandemic.

Meanwhile the class A bond buyers have been collecting 7% with virtually no chance of losing their money by July of 2020 because China is not a developing nation.

The whole setup makes no sense unless failure was the intent all along.

Mike "Mish" Shedlock

Comments (18)
Latkes
Latkes

Good reason for some people to pray for a pandemic, but the money is tiny, barely worth mentioning.

No. 1-8
Runner Dan
Runner Dan

"What is the World Bank invested in or doing with the money to pay way above market rates?"

My guess is they get paid by the poor country being insured.

"But where does the poor country get the money?"

Industry!

"They don't have any industry though!"

Okay, then human trafficking? Maybe to countries that have little regard for human life and easily turn a blind eye to scientist "doing research"? Can you think of any?

4 Replies

Sechel
Sechel

the bonds were designed to raise money from investors and create a windfall to countries that get hit with pandemics. the world bank wasn't investing in anything.
the problem is the 3rd world countries don't really benefit that much since the bankers designed the bonds with the investors in mind more so the crisis would have to be long in duration and truly epic for any pay-out. They pretty much failed to do what they were designed to do in the last crisis.

Runner Dan
Runner Dan

Okay, but where did the World Bank get the money to pay the investors?

I'm thinking the World Bank goes to the third world country, tells them they (the World Bank) have a way to protect the poor country from a pandemic and increase their attractiveness to outside investors by being protected from a calamity. Leader likes the idea, but states he doesn't know where he can get the money. Worldly World Bank says, no problem, we'll send some "consultants" over, separately of course, to show you how to start up "various new businesses" and voila! Deals are struck and the real poor and helpless pay the ultimate price.

Everybody is happy! Except the poor and helpless, but who cares about them?

Sechel
Sechel

that's not how it works. i read the prospectus quickly at work. but it looks like this between the countries and the investors. world bank is not an obligor

Sechel
Sechel

world bank isn't lending money or on the hook. the this is between the countries and the investors .world bank just comes up with the big ideas. larry summers name was involved. that should tell you everything on why this was a bad idea.

Sechel
Sechel

I think the following story which is not behind a pay-wall goes into the issue better.
Interestingly enough these were first touted by Larry Summers who later blamed everyone but himself for the failure of these bonds to deliver to the nations it was designed to help. I still remember Summers angling to head of the Federal Reserve. G-d help us if he succeeds in that dream

SMF
SMF

We had a local story the other day how homeless had won this lawsuit and were awarded $1.5 million. The lawyers got $3.5 million in fees. We know who the real winners were in that case, don't we?

Ditto with these bonds. The people selling this crap are the real winners.

Tony Bennett
Tony Bennett

"At 386 pages, the prospectus"

...

Puh leaze. Obfuscation writ large. STAY AWAY.

...

"What is the World Bank invested in or doing with the money to pay way above market rates?"

...

Nothing. Madoff.2

KidHorn
KidHorn

This sounds like pandemic insurance for poor countries.

Maximus_Minimus
Maximus_Minimus

Just think about it. These bonds pay upwards of 7%. Where does WTO invest the money to top that return? I would like to know, too.

Sechel
Sechel

this isn't a debt obligation of the world bank. they were more like the lead manager and banker on the project. they got a fee. this is between a few investors and a few countries and as I understand it the bankers design these bonds more to the advantage of the investor than the countries issuing the bons so they won't even make out so great


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