Market thinking

Pandemic bonds: How can they potentially help economies post-COVID-19?

Nearly $200m[1] is set to be paid out to some of the poorest countries affected by coronavirus from pandemic bonds issued three years ago by the World Bank. So what are pandemic bonds, and how are they used – and why might investors choose to invest in them?

Pandemic bonds are a type of catastrophe bond – something traditionally issued by insurance or reinsurance companies to spread the risks of natural disasters.

Investors who purchase these particular types of insurance-linked securities usually receive in exchange a higher yield than other fixed income products, in addition to the return of capital. As prices for catastrophe bonds don’t tend to move in the same way than the wider asset class, this can also offer some diversification to portfolios for sophisticated investors.

There is a significant caveat however – investors only receive the principal – the face value of the bond – back if the catastrophic event in question does not happen. If the earthquake or hurricane or other natural disaster occurs, the investor loses part or even all the capital.

 

Where did pandemic bonds originate?

Following the 2014 ebola pandemic on some African countries, which left around 11,000 people dead, the World Bank decided to create a new type of catastrophe bond called pandemic bonds. The first such instrument was issued in June 2017,  as part of the Pandemic Financing Emergency Facility, to quickly help Third World countries to fight possible epidemics in future.

The issue was divided into two tranches: class A with an annual coupon of 6.5% plus the Libor[2] rate, with a risk of capital loss limited to a maximum of 16.67% related to a coronavirus event, and class B, with annual interest of 11.1% plus Libor, but with the danger of losing the entire capital invested. The two tranches of bonds expire on July 15, 2020, but can be extended monthly for a maximum of another 12 months. As well as the $320m raised by the bonds, another $105m was raised in swaps.

 

Coronavirus triggers a pay-out

The COVID-19 epidemic was officially declared a pandemic by the World Health Organization (WHO) on 11 March. But this was not enough for the clauses on the $320m of the pandemic bonds to be triggered right away. There are other conditions that needed to be met, including at least 12 weeks having elapsed since the beginning of the outbreak, which the WHO set at 31 December 2019[3].

In addition, the independent agency Air Worldwide needed to declare the coronavirus pandemic an eligible event, which it has now done, after earlier ruling that the outbreak did not meet the growth rate needed to trigger the bonds. The World Bank said that its Pandemic Emergency Financing 

steering body will now meet to determine how the proceeds of the bonds will be allocated to countries that form part of its International Development Association[4].

 

Where does the financial aid go?

The funds from the pandemic bonds are designed to go to 76 countries that are part of the World Bank’s International Development Association – typically the poorest in the world. The money will provide financial support to those countries to fight the coronavirus outbreak, including financing key responders and government and civil organisations, to help minimise the health and economic consequences of the pandemic.

[1] https://www.reuters.com/article/health-coronavirus-pandemic-bonds/coronavirus-spread-triggers-world-bank-pandemic-bond-payout-idUSL8N2C861O
[2] The Libor (London Interbank Offered Rate) is the European reference rate with which banks lend money to each other
[3] https://www.worldbank.org/en/topic/pandemics/brief/fact-sheet-pandemic-emergency-financing-facility
[4] https://www.worldbank.org/en/topic/pandemics/brief/fact-sheet-pandemic-emergency-financing-facility, 17 April 2020

 

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