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World Bank pandemic bond should be the prototype, not the end

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By Lewis McLellan
07 Jul 2020

The World Bank has abandoned its plans for a follow-up to its pandemic bond. That is a pity. Although its attempt wasn’t perfect, the format is a valuable concept and shouldn’t be abandoned because of one flawed deal.

There is no denying the World Bank deal had its problems. It failed to pay out for ebola in 2019 and coronavirus didn’t trigger payouts until mid-April, thanks to the complexity of the trigger criteria. By that stage, the virus was already well advanced in many of the intended beneficiary countries. For a product that was supposed to deliver funds to needy countries rapidly, it cannot be called a resounding success.

As a result, the issuer was subjected to criticism and has bowed out, shelving plans for a sophomore outing in the format.

But the business of catastrophe financing is too important to be allowed to stagnate by one rough outing. The insurance-linked securities (ILS) markets has had wins, notably with Peruvian and Mexican earthquake bonds. Its track record as a means of providing rapid finance in the event of a catastrophe is better than the World Bank’s pandemic bond implies.

But with many such instruments, the yields required to entice investors makes the instruments an expensive outing for the debtor.

It will be difficult to develop these instruments into a viable market, but the effort is worthwhile. Coronavirus has provided an important reminder that sudden events can cause huge economic shocks, and that huge fiscal support is vital to tackle these.

When the economic fallout started to become clear, the necessity of corporate bailouts was unpopular, with many criticising the recipients for financial irresponsibility.

But it would not be feasible for companies to hold enough cash to mitigate the impact of the sorts of revenue losses they are facing this year. Shareholders would be furious if their companies sat idly on mountains of cash waiting for a particularly rainy day.

Insurance against these eventualities is a partial solution, but really only transfers the problem to the reinsurance sector. Should corporates attempt to insure against sudden exogenous earnings shocks, events of the magnitude of Covid-19 would merely blow up the reinsurance industry instead.

It is only in the vast pool of institutional cash that such huge risks stand a chance of being diluted to a less than fatal strength.

Supranationals should be at the forefront of developing these products. The process will be difficult. Designing triggers, and pricing them efficiently so as to attract investors, as they have been with so many other innovations. They already provide hedging facilities to their clients against commodity price fluctuations or weather events intended to smooth out government revenue, and allow for long term spending plans.

Catastrophe finance instruments like pandemic bonds are a vital tool for efforts like this, and the teething troubles that affected World Bank’s effort should not discourage it, or others, from further attempts.

When the European Investment Bank brought its first Climate Aware structured note in 2007, it faced similar criticism. The EIB at the time admitted that its complexity made it difficult to sell to retail investors. Despite that, and thanks to years of effort, revision and evolution, the green bond market grew to almost $250bn in 2019.

By Lewis McLellan
07 Jul 2020