Pandemic Ebola Crisis:

The World Bank issued a very special bond in 2017 in response to the Ebola crisis. It is said to provide poorer countries with money when a pandemic breaks out.

The paper is considered an indicator of the global disease risk - and it is already responding. Even among health experts, it is controversial whether the rapid spread of the coronavirus is already a pandemic.

On the other hand, the verdict on the financial markets is clear. The answer is yes. This is signalled by the prices of so-called pandemic bonds.

The value of these special bonds has dropped to an average of 50 per cent of their issue price this week. The holders of the interest-bearing securities must fear that the bonds will not be repaid.

This is exactly the case when the conditions for a "pandemic", a worldwide epidemic, are fulfilled.

The price slide in the stocks therefore signals that the likelihood of a global outbreak is rated by the capital market players as very high.

Pandemic bonds were launched by the World Bank in 2017 in response to the Ebola crisis in Africa.

The idea behind this was to provide poorer countries with sufficient capital in the event of a crisis to combat the disease in a targeted manner. The capital should, in turn, be raised by private investors.

And so the World Bank subsidiary International Bank for Reconstruction and Development issued two tranches with a volume of $ 95 million and $ 225 million.

The investors were lured with a double-digit coupon (double-digit annual interest payments). The only catch.

Should there be a pandemic with many deaths, investors would only get part of the money back or, in extreme cases, would even have to write them off entirely.

Because then the paid-in capital would flow directly to the countries in need, not back to the investors.

The pandemic bond seemed to benefit everyone involved. The borrowing pledged the prospect of quick financial aid to countries hit by a plague in the event of a humanitarian crisis.

The World Bank issuer was able to hedge a risk that no insurer would have entered into due to its lack of predictability and only had to pay interest as an insurance premium. And it also sounded like good business for risk-taking investors.

Every year in which there was no pandemic, they would be able to generate double-digit interest income, in times of lower and ever lower capital market returns. The paper in the 95 million tranches generated more than twelve per cent.

Returns uncoupled from market developments:

Besides, the bonds promised returns regardless of the other market developments, i.e. regardless of the ups and downs on the stock exchanges.

The spread of plague is usually an event that does not correlate with the business cycle and central bank cycle, which in turn determines the ups and downs of the markets.

Such uncorrelated assets are extremely rare. Accordingly, both tranches of the pandemic bond were quickly oversubscribed in the 2017 issue, there was more demand for the bond than supply.

But the first blow came in 2018. The prices of the riskier tranche of 95 million slid down to 70 per cent of the nominal value.

The reason was another outbreak of Ebola in the Congo. However, the crisis was not so devastating this time.

In the end, the pandemic fund's thresholds were not reached, which would mean immediate monetary aid for the country concerned but would mean a loss of capital for investors.

For this to happen, according to the terms of the bond, there must be 250 deaths or more in one country and at least 20 in another, and the disease must have spread in different countries.

This is the critical point: with the spread of the coronavirus (Covid-19), such a humanitarian disaster scenario no longer seems unlikely. And so bond prices drop dramatically.

However, the bonds are not traded on public exchanges. Pricing is not very transparent. Few brokers specialize in the trading of paper, and they are also reluctant to publicly list prices.

This is also due to the complicated conditions of the bonds. The prospectus comprises almost 400 pages and contains numerous clauses.

Some of them are so complicated that even for well-informed investors it is difficult to estimate when the pandemic will occur.

For example, the World Health Organization must first publish a so-called warehouse report: 84 days later, the bond expires and the payment is made.

The prices of the pandemic bond, therefore, predict with high certainty the worldwide spread of Covid-19. But they are not 100 per cent safe either.

"There are always monsters under the bed, sometimes they are real monsters and sometimes they are only perceived," said Mark Spitznagel of Universa Investment to Bloomberg financial news service.

The hedge fund manager specializes in hedging rare risks that involve high losses for investors - so-called tail risks.

According to the expert, pandemic bonds bring little, because they fall in value when the financial markets collapse across the board for fear of the consequences of a possible pandemic.

Uncorrelated investments are now becoming a highly vulnerable investment in the crisis.

Spitznagel does not want to commit to who is right in the case of Corona: "You cannot completely trust the markets that tend to panic and often overshoot upwards or downwards". Public institutions and health experts are also often wrong in the case of epidemics.


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