Odd Lots - What the Coronavirus Means for Pandemic Bonds

Episode Date: February 17, 2020

Back in 2017, the World Bank issued the world's first pandemic bonds. The bonds are meant to shift some of the financial risk of a global pandemic on to investors, but they've been criticized for having 'triggers' that are too tough to generate payouts. Now, as the coronavirus outbreak continues to spread, it's worth looking at how these bonds are structured and what they can tell us about the future of public-private partnerships in finance. In this episode of Odd Lots, we speak with Olga Jonas of the Harvard Global Health Institute, and a former economist at the World Bank with significant pandemic experience. She gives us her take on the bonds as well as the economic impact of big epidemics.See omnystudio.com/listener for privacy information.

Thanks for listening to Odd Lots. Follow the show on Amazon Music for more future episodes or just ask, Alexa, play the Odd Lots podcast on Amazon Music. Today's show is brought to you by Vanguard. To all the financial advisors listening, let's talk bonds for a minute. Capturing value and fixed income is not easy. Bond markets are massive, murky, and let's be real. Lots of firms throw a couple flashy funds your way and call it a day. But on Vanguard, at Vanguard, institutional quality isn't a tagline. It's a big line. It's a very big. It's a lot of firms. It's a few. commitment to your clients. We're talking top-grade products across the board of over 80 bond funds, actively managed by a 200-person global squad of sector specialists, analysts, and traders. These folks live and breathe fixed income. So if you're looking to give your clients consistent results year in and year out, go see the record for yourself at vanguard.com

slash audio. That's vanguard.com slash audio. All investing is subject to risk vanguard marketing Corporation distributor. Hello and welcome to another episode of the Odd Lots podcast. I'm Tracy Alloway. My co-host, Joe Wisenthal, is away this week. So the entire world has been watching the outbreak of a deadly new coronavirus, and I have to say I'm recording this podcast from my apartment in Hong Kong, and a lot of workers in the city have now been asked to work from home. And as I'm recording, there's this huge thunderstorm outside. So apologies, if you hear, in the background, but I got to say, the entire atmosphere of Hong Kong at the moment feels kind of apocalyptic. This morning, China just reported an extra 15,000 coronavirus cases after

changing its methodology for diagnosis. And that takes the total cases to more than 50,000 in Huve province alone, the epicenter of the outbreak. Deaths are now well over 1,000 people. That's according to official numbers. And of course, there's a lot of doubt surrounding those official numbers. And in between sort of obsessively checking my temperature all week and trying to find masks in Hong Kong, most of them are sold out, there's another thing that I've been obsessing over, and that is the World Bank's catastrophe bonds. Now, these aren't just any catastrophe bonds. Cat bonds are typically linked to things like hurricanes and earthquakes and other natural disasters, but the ones we're going to be talking about today are a 320 million.

million-dollar cap bond issued back in 2017 that's linked to pandemics. In fact, it's the first pandemic bond ever. And it was sold in response to the Ebola outbreak from a few years ago. And the bond basically backs the World Bank's pandemic emergency financing facility. The thing that is used to fund fighting these kinds of global outbreaks. Now, the idea behind the bonds is that There are a way for investors to bear some of the financial risk of a global pandemic. If an outbreak gets bad enough, then the bonds get triggered and their principal value gets paid into the World Bank's account to help fund containment efforts against whatever disease is currently wreaking havoc. In the meantime, investors get to earn interest. And I ought to say, it's pretty good interest.

The riskiest tranche pays about 11%, I think, over LIBOR, and the least risky tranche pays. something like 7% over LIBOR. Now, I just mentioned riskiest tranche and the least risky tranche. And as you can imagine, there are different payout triggers for different parts of the bond. And they come into action at different points in time. And defining a pandemic isn't something that normally comes up a lot in finance. I think it's worth digging into these bonds to see exactly what those triggers look like, what the structure looks like, how people in finance.

think about global pandemics and also what we can learn about pandemic containment efforts in general. And so today we're going to talk with one of the critics of the bonds, but also someone who has a lot of experience from an economics perspective with pandemics. Our guest is Olga Jonas of the Harvard Global Health Institute and also a former economist at the World Bank. Olga, thanks so much for coming on. Thank you very much. Very glad to be here.

So I guess my first question is how did you get interested in this particular bond issue? Because I've seen you on Twitter and you tweet quite a lot about it. And of course, there aren't that many people out there on social media who are talking about pandemic bonds. Yeah. Well, I mean, the origin was that I was working. I'm a macroeconomist. But in 2005, I was in a central policy department at the World Bank. It was at that time that the international response to avian influenza and the pandemic threat from avian influenza was launched.

And, you know, just was a fortuitous coincidence that I was in the department where this response was managed for the World Bank. So I got very interested in pandemics and pandemic risk because it's really very much underappreciated. and it's not studied very seriously because, you know, between episodes of emergency, people forget about this risk and it's not something that they worry about, which, you know, is a mistake. And as we went through the response to avian and pandemic influenza from 2005 to 2010, you know, it became clear that the world is not ready for a pandemic, that there are just, you know, the capacities to prevent it.

prepare and to prevent such a catastrophic event, you know, are feasible, but they are just not there in the poorest countries. So we became very interested in sustaining the momentum from the avian who responds into, you know, building the capacities to prevent and to be better prepared for the next episode, which will necessarily come, as they say, you know, it's not a matter of if, but when. But unfortunately, this was sidelined and, you know, it just didn't occur, and that was a very disappointing experience, very frustrating. And then, you know, the Ebola outbreak in 2014 was a reminder that poor countries, this was in West Africa, where we saw that, you know, it devastated the economists and then too many people died in Liberia and Sierra Leone and Guinea. And afterwards, there was momentum to sort of renew the efforts toward being prepared next time.

And instead of focusing on the capacities in the countries, the World Bank went this other route. But unfortunately, it was not a priority. Priority is definitely in the countries to be better prepared. And this was very much a response. Well, what if there is a pandemic? I mean, how do we get more money kind of response. But not only is that not a lower priority, but it also was shown to be not feasible to design it in a way that it would work.

So it's a sort of accumulation of errors of judgment and analysis that brought us to where we are today. So Olga, just to back up for one second, So you were talking about, you know, the preferred way of dealing with a pandemic would be to have a domestic health care system that is capable of responding on its own. But there was a preference for figuring out some way to get additional money funneled into a particular country or against a particular series of countries if they're hit by the pandemic. So how exactly are these bonds supposed to work? how does the money get to the World Bank? Well, it's supposed to work the way a cat bond works, which, you know, there are parametric triggers,

but it proves to be very challenging to define the triggers because it's very difficult to anticipate how an epidemic, you know, when it starts, it's an outbreak, and then it becomes an epidemic. And the idea is that you have to intervene as soon as possible at the beginning. to prevent the further spread, right? But that's very difficult to anticipate what it will look like.

And that's why in designing it, they shows triggers that are much later. There is, in fact, a condition that it has to be at least 12 weeks after the beginning of the outbreak before anything can be triggered, as well as the number of deaths, you know, the high number of deaths and the growing rate of the outbreak. So that means that it's triggered much too late. But if it was triggered earlier,

then the price of the insurance would be much higher, right? Because there's just so much uncertainty in the modeling. And much of the uncertainty in the modeling is due to the lack of data on these kinds of events. And the lack of data is due to the lack of public health system, in developing country, which is what is needed to invest in, not health care system. You know, it's not all health care. It's not hospitals and clinics and all that.

It's just the basic, it's called core public health functions, which is the capacity to detect, to diagnose, and to respond to an outbreak. And that's not, you know, very expensive. It's, in fact, highly affordable compared to the benefit. And that hasn't been done. That's what has been sideline. And you need that to do modeling that would actually enable insurance maybe in 30 years from now when the health systems are in place to generate the data that you need to do the modeling.

So there seems to be a tension here because obviously if you're fighting a pandemic, you want this extra money as soon as possible. but the terms of the bonds make it difficult for them to pay out because, A, you have this sort of 12-week limit that you just mentioned, and you also have to have deaths that take place in other countries outside of the original outbreak country. You mentioned that data is quite hard to get when there is a global pandemic. So who's the arbiter of when these bonds actually pay out? How do they verify that the trigger has actually been met? Well, there is an actual verification of the triggers is spelled out in the prospectus of the for the bonds, which is 386 pages long.

And there is a verification agent, which is a firm. It's a commercial contract between the World Bank and the verification agent, and they are going to ascertain whether all the triggers have been met. But the triggers are, triggers have been described as a maze of confusion. So, you know, this is not a trivial exercise to verify these triggers because it's really quite complex. I mean, it takes 386 pages to set out the terms of the bonds. So when the verification agent notifies the World Bank that, you know, the triggers have been met, then the World Bank would get the money from the bond bonds,

because it's holding that money, right? Right. What's the maximum payout that the World Bank could get? Well, that's the other issue. That's very disappointing in this whole experience, is that for coronavirus, when you look at it, the first payout, if it happens, right? I mean, there's no certainty now, I mean, there's no way of telling, at least from where I said, whether it will happen.

It will be $131 million, and the maximum payout is $196 million. And that will have to be divided among the 76 poorest countries. It's about $0.8 per capita, because there are more than 1.6 billion people in the poorest. countries that are eligible to, you know, get the proceeds. So it's eight cents per capita, which, you know, and when you compare it to what China is already spending on its response, right, which we have all seen on the dramatic images of hospitals being built in one weekend and all cities under quarantine, and they have announced that they have already allocated $10 billion.

for their response. So you can see that, you know, if the poorest countries in the world with more, a bigger population than China together, they will get only, you know, a fraction of what China is already spending. So it will not make much difference. It will be too little, too late. Do you think the bonds will trigger for the coronavirus outbreak? I hope they do. You know, I mean, I really hope they do.

because one of the sort of tragic aspects of this is that, in fact, the payment for the cost of the bonds, that means the premiums and the interest and the fees that were associated with this pretty complicated transaction, that those add up to $150 million. dollars and those funds actually came from funds that were intended for the poorest countries. They came from Ida, which is the soft loan window of the World Bank, which is, you know, money that donors gave for the World Bank to finance productive projects in the poorest countries. So that was 50 million from Ida. Then 50 million was donated by Japan, but I'm sure, you know, the Japanese government

intended that their donation of 50 million benefits the developing countries, benefits the poorest countries, protect them from pandemics. And then 15 million was donated by Germany. So also, you know, taxpayers, taxpayers in Germany, taxpayers in Japan. So altogether, 115 million has been paid for premiums and interest, I mean, for the interest and for the premiums and for the premiums and for the fees to beneficiaries or, you know, to recipients who are not poor, who are in high-income countries.

I mean, these are investors who, of course, they, you know, invested their funds and they are, you know, at risk of losing some of this money because of the triggers. But, you know, that's a very high return. As you mentioned, it's 11% of libel or 7% of libel for the other. ranch. Those are very generous returns in today's market conditions. And, you know, then I think you mentioned in your introduction that the idea was that the investors or the private market would share some of the risks of a pandemic and, you know, thereby contribute. You know, in fact, when a pandemic worsens more than it is already and anticipate that it will worsen, the

markets will, you know, decline. I mean, prices of assets fall. So investors are already going to be losing a lot of money just because there is a pandemic, right? Today's show is brought to you by Vanguard. To all the financial advisors listening, let's talk bonds for a minute. Capturing value and fixed income is not easy.

Bond markets are massive, murky, and let's be real, lots of firms throw a couple flashy funds your way and call it a day. But not Vanguard. At Vanguard, institutional quality isn't a tagline. It's a commitment to your clients. We're talking top-grade products across the board of over 80 bond funds, actively managed by a 200-person global squad of sector specialists, analysts, and traders. These folks live and breathe fixed income.

So if you're looking to give your clients consistent results year in and year out, go see the record for yourself at vanguard.com slash audio. That's vanguard.com slash audio. All investing is subject to risk vanguard marketing corporation distributor. So these were pitched as sort of something that should kind of be uncorrelated with the broader market. But in fact, whenever they trigger, if they actually trigger, it would probably be because something quite serious was happening. And therefore, markets around the world would be falling anyway. Exactly.

So investors sort of get a double whammy. So for the investors, it's not that I don't see how there could be a much, a diversification benefit because these bonds are going to move with the market and the prices, right? So who aren't the investors who bought these? Who's a typical buyer of this kind of bond? Well, I think, I don't actually know. I think, you know, they were just investors who buy cat bonds who, you know, want to see

them in their portfolios as an element. I think there are some pension funds who bought it, but it's definitely the high returns have not been earned by developing countries. I'm quite certain. It's all high income investors. Do you think there's any way to structure this kind of bond in a way that would be satisfying or attractive for investors, but also ultimately fulfill the purpose of a pandemic bond for public health, which presumably is getting extra money to the World Bank as soon as possible? No, well, number one, the World Bank does not need extra money to respond to pandemics.

You know, the World Bank is not a budget-constrained entity. It's a bank. And Ida, the Fund for the poorest countries, is the largest multilateral fund, you know, public fund, to support development in poor countries, which includes for the last 50 years responding to emergencies, because emergencies occur as a matter of, I mean, often, right? And Ida has very, you know, ample liquid assets. It has reserves. It lands, it, you know, makes new loans worth now $27 billion every year, right? So, and the allocations are done on a three-year basis.

So now it's allocating $82 billion for every three years. It's a rolling process, right? So there is, you know, you cannot, nobody can say that the World Bank needs more money in order to respond to outbreaks. The World Bank does have the money, and that's the very purpose of the World Bank. I mean, that's why it was set up. It was set up to support countries. in their, you know, for their priority needs as circumstances change.

And if there is an outbreak of Ebola or coronavirus, the money is not the issue. It's the preparedness of the World Bank to respond to, you know, deliver the financing on the ground and the preparedness of the country to, you know, implement the activities that are necessary to control the outbreak. but money has never been the issue. I mean, if you have $82 billion in the fund, you do not issue bonds at LIBOR plus 11% to obtain $196 million in case there is a coronavirus, right? It's just, I mean, the World Bank has ample reserves to deal with outbreaks in Ida country.

So this was more of a sort of attention-getting initiative to have an innovation, to try to innovate in this space. But it was not needed and it did not work. So I want to broaden out the conversation a little bit and go back to some of your experience as an economist dealing with other epidemics such as avian flu back in the early 2000s. what lessons did you learn as an economist dealing with those sorts of epidemics? Because I must admit, I don't really know exactly what the role is of an economist at the World Bank in dealing with those kind of outbreaks. What did you actually do? And what did you learn?

Well, you know, what's astonishing is that how underappreciated the economics of epidemics were or still are, because there's very little realization that if you act early and if you are prepared to stop the outbreak when it's just a few cases, you know, before it spreads, then in fact you are avoiding a huge cost later and the huge cost is due to the exponential threat, you know, the exponential growth that can happen with these diseases because like two people give it to four people to, you know, 16 people, etc. It's a very rapid progression of growth. And that's not understood by the sort of bureaucratic processes that we have in place to respond to disasters. You know, because usually it's a disaster that occurs and then there's an estimate of the costs of rebuilding,

like in a hurricane or in an earthquake, and then there are activities to rebuild. But in this case, you are averting something that hasn't happened yet. So there's an overreaction in reacting, but at the same time, there's the lack of appreciation of how much money you save

by reacting early and being prepared. So that's why there's this repetition of, you know, panic and then it's forgotten because in the health sector there there are so many unmet needs that people's attention shifts somewhere else there's always some other priority that comes up and catches attention and then you know that accounts for the high costs of responding the next time if the bank is not prepared the countries are not prepared it's very difficult. And we are seeing it again with coronavirus because basically from 2015, which was the end of the last epidemic, that was sort of a major epidemic in West Africa, you know, not much

has happened to improve preparedness across the poorest country. So you mentioned that after other disasters like a hurricane or an earthquake, there's sort of building activity that starts up immediately afterwards. And I would assume that that maybe helps stimulate the economy in one way or another. In your experience or in your research, after a pandemic, what sort of economic impact does that have in the long term? Does the recovery, the economic recovery after a pandemic look different to the economic recovery after an earthquake or a hurricane? I mean, sort of a high-level answer is know that it's a, you know, macroeconomically, it's a temporary shock that passes as soon as, you know, the disruptions of travel and trade and, you know, supply chains, you know, when that comes to an end, then things return to normal and there's a, there's no permanent effect. However, when this happens in very poor countries like what happened in West Africa in 2014-16,

the Ebola outbreak had a very severe effect on the health care system. A large number of doctors and nurses died, and when you think of that in the context of a poor country that does not have enough doctors and nurses and these kinds of human capacities that make the healthcare system work. And when they lose them in an uncontrolled outbreak, which is what the Ebola was in West Africa for the first year, certainly,

then that says the country back because it takes many years to train new and it's expensive also to train new doctors and nurses. So there you would see development. I mean, they estimate that the West Africa development was set back by a decade. So losing a decade of growth in very poor countries, that's very serious. You know, the coping with these events is much more difficult in poor countries. and in poor communities.

So there the effects, you know, would be longer lasting than in countries that are much more robust and resilient. You know, when the worst is over it, you can return to normal, hopefully. How do you see this playing out in China specifically? We look with astonishment at the measures that are being implemented in China. and I'm no expert in China or these kinds of measures. And I can only hope that it works. We should all hope that it works.

Thank you so much, Olga. That was really interesting. Thank you. Thank you for having me here. Thank you so much for coming on all thoughts. So Joe's away. So I'm just going to talk to myself for a couple minutes. But I just wanted to say I always find that kind of.

deep dive into bond documentation very fascinating. And I find this particular conversation fascinating, not just because coronavirus is impacting so many people around the world at the moment and also global markets, but also because these pandemic bonds remind me a little bit of ESG investing, which is the other hot topic in finance at the moment. Investors buy stuff that's supposed to be environmentally friendly or aimed at some sort of social good or governance-related thing. And too often, we're not asking the right questions about how these things are necessarily structured, who's doing the due diligence on them, who's monitoring performance versus payout. A lot of people just seem to be reaching for the hot new thing that happens to come with a,

you know, cuddly, do-good label. And the pandemic bonds remind you, me a lot of that. Now, if you want to read more about these, my Bloomberg colleagues, John Lowerman and Tasso Vossos, also wrote a great piece about the pandemic bonds last year. Definitely worth reading. So, this has been another episode of the Oddlots podcast. I'm Tracy Alloway. You can follow me on Twitter at Tracy Allaway. You can also follow my absentee co-host, Joe Wisenpaw at The Stallwart. And you can follow our producer. Laura Carlson at Laura M. Carlson. You can also follow all of Bloomberg podcasts at the Twitter handle at podcast. Thanks for listening. June Grasso, inviting you to join me for the Bloomberg

Long podcast. Every weekday, we help you make sense of the legal stories that shape the nation and the world. Listen for complete analysis of the biggest court cases, the latest actions from Congress and regulators, and the legal moves driving the markets. from corporate law to constitutional law and from state courts to the Supreme Court. At Bloomberg Law, we go beyond the day's headlines. We speak with top attorneys, judges, scholars, and policy experts to break down what the rulings really mean. We do this every weekday, then bring you the best conversations in our daily podcast.

Search for Bloomberg Law on YouTube, Apple, Spotify, or anywhere else you listen. On the East Coast, listen as you start your podcast. your day and on the West Coast, catch up in the evening. That's the Bloomberg Law podcast with me, June Grosso. Subscribe today wherever you get your podcast. What separates good leaders from transformational ones? I'm Jessica Chen and in season two of Leading By Example, we'll sit down with executives like Grace Chen of Bertie Gray to find out. It's important to understand where you spike, but also really acknowledge where you don't and find people who can fill those gaps.

Listen to leading by example, executives making an impact on the IHeart radio app, Apple Podcast, or wherever you get your podcasts.