In today's newsletter we talk about the exotic new bonds in town and why it's embroiled in controversy.

Markets

The Story

Back in 2014–16 the scourge of Ebola ravaged most of West Africa and the global community (the World Bank in particular) was restricted to watching the devastation unfold from the sidelines.

The premise was simple. West African countries could have contained the virus if they had the necessary resources to fight the outbreak early on. Unfortunately, they were severely constrained for said resources and as a result over 11,000 people lost their lives. So the World Bank needed a fix. They could no longer wait to complete a thorough assessment of the damage and then mobilize funds. This was a moot consideration. Instead, they needed to deploy funds the moment they’d realise that the pandemic was likely to gain momentum.

So they devised an ingenious strategy. Instead of funding these relief programs themselves they decided they could partially offload the burden to private investors.

Here’s how it works. You go to multiple investors, ask them for a $1 Million each, promise you pay back (if all goes well) in 3 years and throw in a 13% annual interest payment on top. It’s a very enticing deal. Money comes in thick and fast and before you know it, you’ve mobilized $100 Million.

But how will you fund the interest payment? Well, if you are the World Bank you will simply stash the $100 Million in low-risk assets. This gets you about 6% annually and the rest you fund it yourself  (through the donations you receive from partner countries)

But why would you do it?

Well, because the private investors promised to help you out in the event of a pandemic. Ergo, your commitment to pay back the investors in full is only valid if there is no disease outbreak. In the event that a pandemic does strike, then you, as World Bank can channel the $100 Million corpus you’ve mobilized and deploy it in crisis-hit countries.

So in return for the 13% annual payment, the investors bear the risk of losing their entire principal. You pay their interest. They help you out during a crisis. What we have here ladies and gentlemen is a pandemic bond.

Anyway, while the idea sounds extremely enticing, it does pose some very interesting problems. For one, the payout can only be triggered if specific pandemic-like conditions are met. Conditions that are included in a 386- page prospectus that are extremely hard to interpret. And so, even if we do have people dying in large numbers, the funds may be never be deployed because the specific conditions required to trigger the payout haven’t materialised.

As Matt Levine writes for Bloomberg

As is so often the case in financial-contract triggers — there is room for debate and gamesmanship. So it’s not a pandemic unless there are deaths in multiple countries — a devastating epidemic in one country would not trigger the bonds — and so you get this gruesome speculation. [Will it trigger or will it not? Consider for instance the strange situation that cropped up in Congo]
“They only needed 20 bodies on the other side of the Congo border to get to the trigger. What if someone loaded up a truck and dumped those in Rwanda?”

And there you have it. What if the World Bank was simply tempted to commit fraud and trigger the bonds so that the funds could be deployed. Well, it’s a possibility. But you know the World Bank would never do it even if it’s for a just cause.

Even others contest that the conditions are specifically rigged to trigger payouts only after outbreaks grow large. This makes it more enticing for private investors because they’ll know for sure their principal will stay intact. So irrespective of whether the bonds actually help countries fight pandemics, investors will always make money. Or maybe, this whole thing is a marketing gimmick. I mean, it’s the World Bank we are talking about. You honestly think they’d need private investors to pump in cash for their relief efforts?

Olga Jonas, a Harvard Senior Fellow and an outspoken critic of the Pandemic bonds alleges that the World Bank didn’t even need to issue bonds to better prevent pandemics. The former economist called the instruments a “distraction” from “getting serious about supporting preparedness” in developing countries. The $500 million made available through the PEF (pandemic emergency financing facility) is a paltry sum compared to the tens of billions of dollars the World Bank holds in liquid assets (like cash)

And so, everybody is asking the same question right now—Why on earth do we need one of these things?

Do you have an answer? Let us know what you think.

Until then, stay safe.

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