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Pandemic bonds look set to pay out

Arthur Sullivan
February 26, 2020

Pandemic bonds sound like a curious financial concept — but they were brought in by the World Bank in 2017 to help developing economies. Against the odds, the coronavirus outbreak may see investors lose money on them.

Tokio Börsen mit Verlusten
Image: Imago Images/Kyodo News

A global pandemic? Don't bet against it. That appears to be the verdict of stock markets around the world, not least when it comes to the somewhat unusual financial instrument known as pandemic bonds.

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 idea behind the bonds was to place some of the risk for low-income countries of a pandemic onto the financial markets, rather than their own governments' budgets. Investors who bought the bonds would only lose money if certain trigger conditions relating to a pandemic were met.

If those conditions are triggered, the bonds are not repaid in full and the money is used instead to help tackle the crisis in developing countries.

The growing coronavirus outbreak around the world has prompted many of the investors who bought up the bonds to sell them off, as it looks increasingly likely that the conditions for the bonds not to be paid back will be met.

Stringent conditions

Since the scheme was initiated almost three years ago, the conditions for payout to countries afflicted by pandemics have not yet been met, but the new COVID-19 coronavirus outbreak looks like it will do so.

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. 

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.

Although no second country has recorded 20 deaths at the time of writing, Iran, Italy and South Korea have all recorded more than 10 with the numbers rising steadily in recent days. Other conditions for this bond include that there are 250 deaths in the origin country (already long since passed in China) and that 12 weeks have passed since the original outbreak (a condition which will be met on March 23).

In the terms of both bonds, it is stipulated that coronavirus outbreaks count as one of the diseases covered.

Italien Mailand | Vorsichtsmaßnahmen Coronavirus | Menschen mit Atemschutz
Italy's death toll is close to the level that would trigger a pandemic bond payoutImage: picture-alliance/dpa/abaca/Ipa

Controversial instruments of aid

Despite the fact that the so-called pandemic bonds look set to result in a payout to developing countries, critics have said the conditions are too stringent and that investors have already made money on them due to the regular coupon payments they have received on the back of the initial purchase.

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 Jonas, 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."

"Early action against outbreaks is imperative, because it is both more effective and less costly. But making the bonds attractive to investors meant designing them to reduce the probability of payout," she wrote last year in the scientific journal Nature, several months before the novel coronavirus outbreak begun.

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.

Ebola Impfung Kongo
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 bondsImage: picture-alliance/dpa/J. Delay

The World Bank's bond sale was 200% oversubscribed, meaning investors saw moneymaking opportunities with the high-yield returns on offer. Most buyers came from Europe, and included specialized catastrophe bond investors as well as asset managers and pension funds.

According to Bloomberg, asset managers including Bailie Gifford, Amundi and Stone Ridge Asset Management are among those who hold the riskier Class B bonds.

The interest and coupon payments made to investors have been funded largely by the donor nations Japan and Germany.  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.

Haves and have-nots

Even if some developing nations do end up receiving pandemic bond money, it will be a relatively trivial sum when compared with some estimates of the economic damage a sustained coronavirus pandemic would do to developed and developing economies alike.

USA Weltbank-Zentrale in Washington
The World Bank (headquarters pictured above) said in 2017 the bonds were 'a momentous step that has the potential to save millions of lives and entire economies from one of the greatest systemic threats we face'Image: AFP/E. Baradat

The Oxford Economics think tank estimated last week that the spread of the virus to regions outside Asia would knock 1.3% off global growth this year, the equivalent of $1.1 trillion in lost income.

Yet one stark illustration of the different capacities rich and poor nations have to cope with the crisis came with the news that the Hong Kong government would give HK$10,000 ($1,280) to permanent residents of the territory whose finances have been hit by the spread of the virus.

That would amount to $10 billion in cash handouts, far in excess of the amount of money developing countries would receive as a result of pandemic bond payouts.