Who should pay for natural catastrophes?

Over the weekend, Harris County in Texas voted in favour of issuing bonds to pay for flood defences, a year after Hurricane Harvey caused terrible damage in the Houston region. It is part of a wider tussle over who bears the risk of catastrophes — and the capital markets are at the forefront of the discussion.

  • By Jasper Cox
  • 28 Aug 2018
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Republican Party bigwigs lining up in favour of tax increases and more state spending is an unfamiliar sight in the US these days. But when Harris County, which contains the city of Houston, voted on Saturday in favour of issuing up to $2.5bn of bonds with proceeds tied to flood control and protection measures, it was welcomed by local party officials.

It was supported by the Republican chief elected official of the county, Ed Emmett. Local resident and former US president George HW Bush voted for it. The Democrat mayor of Houston, Sylvester Turner, also supported it.

The vote is a sign of an intense focus on how to protect against natural catastrophes in an age of unpredictable climate change.

The proceeds from the bond will be used to fund risk reduction projects from a list currently standing at 237 projects. The notes will be sold incrementally over a period of at least 10 years. The country’s budget management office estimates it will result in a tax increase of up to 2-3 cents per $100 of home valuation.

The fact of the vote itself, and the decision to tie it specifically to certain projects, is not in itself unusual. In Texas, voters must approve bond issues that result in public debt and implicate a tax increase. The purpose of the bond must also be laid out, so funding cannot be diverted to other areas.

Harris County issues a bond every five to 10 years, and cities and school districts also issue notes, according to Joe Stinebaker, communications director for Emmett. This means voters probably consider about one bond proposal per year.

But this particular bond will give flooding risk officials a giant windfall, showing how the spectre of Harvey has forced the county into tough decisions about the state’s role.

“There is not sufficient cashflow from normal taxation to address the needs for flood-related deficiencies that were so evident over the last few years,” said Jim Blackburn, professor of environmental law at Rice University in Houston. “We had gotten behind on our flood-related defences.”

The Harris County Flood Control District, which works on designing and building flood risk reduction projects, has an annual budget of around $120m, of which half goes to capital projects and half to operations and maintenance.

This is not all. It also accesses federal grants: last year it completed around $120m in total for projects. “Still, you can compare that to $2.5bn,” said an official at the entity.


Equitable distribution

Warmer oceans as a result of climate change make tropical cyclones more intense, bigger, longer-lasting and wetter. This was the finding of a recent study in the Earth’s Future journal, which specifically looked at Hurricane Harvey.

With climate change increasing the risk of other disasters, other parts of the US are asking voters about whether to boost defences. Last year voters in Miami supported a measure to raise debt to mitigate the effects of rising sea levels and flooding. And residents in Seattle and San Francisco Bay have also voted in favour of raising funds through tax or debt to bolster protection against the sea.

In Harris County the desire to act was unsurprising. Hurricane Harvey flooded 159,000 homes across the county, according to Stinebaker, and there were 36 flood-related deaths. It ranks as the second costliest tropical cyclone to hit the US, according to the National Hurricane Center, with the damage worth $125bn.

When asked whether Harvey had changed people’s opinions about paying more in taxes to raise money for defences, Stinebaker replied: “Without a doubt.”

“While it was the most severe storm to hit our county, it was only the most recent of a handful of dangerous floods to devastate our region in recent years,” he added. “As a result, the people of Harris County have come to see flooding as a top public safety issue.”

And for his part, Blackburn thinks the hurricane has prompted officials to think more about poor people particularly at risk.

“There is a perception that in the past, the lower income community is asked to vote for bonds but never receive a fair share,” he said. But this time, “the county went out of its way to be transparent and to promote equity: two things never done in the past. The elected officials reached out to groups normally not in the middle of the politicians’ thinking”.

This, along with the bipartisan support for the measure and transparency over the process, should be useful for other territories considering whether to do something similar, Blackburn said.


Not just the state

The debate about who foots the bill for natural disasters, and who bears the risk, spreads into other sections of the US markets beyond state-issued debt.

In California, rising temperatures and falling precipitation, coupled with increasing population density in high-risk areas, have resulted in more numerous damaging wildfires.

Four of the 10 most destructive ones, in terms of structures destroyed, have occurred since last October, according to ratings agency AM Best.

Utility firm PG&E chose to use a catastrophe bond to give itself protection against property damage claims, where damage is caused by wildfires which it is responsible for starting. Under Californian law, the firm is liable when its equipment, such as electrical wires, causes a wildfire.

This feature of the law may not have mattered much when wildfires were not a big threat. But when the damage caused by wildfires becomes large enough, who is responsible is a much hotter topic.

In a business update last month, PG&E said it accrued charges of $2.5bn over the first half of the year related to estimated third party claims in connection with 14 of northern California’s wildfires. JP Morgan says PG&E’s liabilities for the 2017 fires could rise to $17bn.

The utility firm’s share price has fallen by 36% since last October, from $68.13 to $43.61, and it is affecting its credit too.

"Final causes of the northern California wildfires have yet to be determined, potentially exposing [PG&E Corporation] to material contingent, off-balance sheet liabilities,” said Jeff Cassella, a senior analyst at Moody’s earlier this year. “Long-term climate change risks, like droughts and wildfires, are manifesting faster than regulators and legislators can react to protect PCG from exposure.”

The state’s lawmakers did examine tweaking the law to make sure courts took into account whether utilities acted reasonably when ruling on their liability for fire damage.

But now politicians are proposing to allow utility firms to issue bonds to cover wildfire liabilities. The bonds would be paid through charges added to customer bills. Legislators are expecting to vote on a bill this week.


Markets in a ‘hothouse’ Earth

In terms of risk, that proposal represents a transfer on to the customers. Catastrophe bonds, as a type of insurance-linked security, transfer risk on to the capital markets (although one could argue customers will also bear the brunt of PG&E’s increased insurance costs).

Catastrophe bondholders lose their principle if the bonds are triggered by a catastrophic event, which allows funds to be dispersed to the issuer. Worldwide supply of the product is dominated by natural catastrophe risk in the US.

Indeed, catastrophe bondholders were on the hook for losses from Hurricane Harvey. But PG&E’s bond is thought to be the first to protect solely against wildfire risks.

Both Harris County and PG&E exemplify a broader tussle over how to protect against natural catastrophes in an era of climate change. And those in line to face damages are relying on the capital markets, either as a form of insurance or to raise funds.

Those in finance are slowly putting systems in place to incentivise green funding. But scientists warn that the earth is already at risk of falling into a death-spiral “hothouse” state, where feedback mechanisms cause global warming by themselves.

The capital markets are likely to be forced into adapting to the effects of climate change before they can do much to halt it — even in the richest country on Earth.

  • By Jasper Cox
  • 28 Aug 2018

All International Bonds

Rank Lead Manager Amount $m No of issues Share %
  • Last updated
  • Today
1 Citi 330,488.64 1282 8.09%
2 JPMorgan 322,584.56 1394 7.90%
3 Bank of America Merrill Lynch 296,928.01 1015 7.27%
4 Barclays 249,873.33 927 6.12%
5 Goldman Sachs 220,211.32 736 5.39%

Bookrunners of All Syndicated Loans EMEA

Rank Lead Manager Amount $m No of issues Share %
  • Last updated
  • Today
1 BNP Paribas 46,112.22 182 6.98%
2 JPMorgan 44,545.29 93 6.74%
3 UniCredit 35,639.50 153 5.39%
4 Credit Agricole CIB 33,211.72 160 5.03%
5 SG Corporate & Investment Banking 32,419.80 126 4.91%

Bookrunners of all EMEA ECM Issuance

Rank Lead Manager Amount $m No of issues Share %
  • Last updated
  • Today
1 JPMorgan 13,792.73 61 8.96%
2 Goldman Sachs 13,469.15 66 8.75%
3 Citi 9,716.40 55 6.31%
4 Morgan Stanley 8,471.86 53 5.50%
5 UBS 8,248.12 34 5.36%