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Barbados embeds parametric nat cat clause in sovereign bond issue

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The Caribbean island nation of Barbados is one of the first in the world we’ve heard of to embed a parametric natural catastrophe event trigger within a sovereign bond issuance, with the occurrence of a natural disaster able to trigger a deferral of payments to holders of the dollar-denominated bond.

light-ideaInterestingly, Barbados has elected to work with the CCRIF (Caribbean Catastrophe Risk Insurance Facility), a provider of sovereign parametric natural catastrophe insurance to Caribbean and Central American countries, as the reporting agent of sorts for its recent bond issuance.

This isn’t a catastrophe bond, but it is another interesting way of protecting the economic interests of a country against additional burden created by the occurrence of major natural disasters.

While at the same time, protecting bondholders by not passing on the natural disaster-related default risk that is inherent in any bond issue from a country exposed to catastrophe events to them, given the deferral is baked into the terms.

The sovereign bond issue features defined events that could trigger a deferral of payments to bondholders, which include tropical cyclones, earthquakes and significant rainfall events.

These events will be defined and measured by the CCRIF, with the CCRIF acting as an event reporting agent of sorts.

As a result, its akin to a parametric trigger that is sitting within this sovereign bond issuance.

Fitch Ratings commented on the bond issuance, “The issue includes provisions for payments to bondholders to be deferred for up to two years in the event of a pre-defined natural disaster. This is intended to adjust the profile of the repayment burden on the issuer, and not to transfer the risk of the disaster event to bondholders. This contrasts with natural catastrophe (Cat) bonds where bondholders are not repaid if a qualified catastrophe event occurs.

Adding, “The bond documentation sets out measurable deferral events (including earthquakes, tropical cyclones and excess rainfall) with reference to the definitions set out by Caribbean Catastrophe Risk Insurance Facility (CCRIF), which is also responsible for confirming whether an event has occurred. ”

The bond natural disaster clause can be triggered a maximum of three times in its term, which runs to October 1st 2029, but not after October 2027 so the maturity cannot be affected by a two year deferral of payments.

There are other clauses surrounding the nat cat trigger that will protect investor interests.

Fitch explained, “The deferred amounts are capitalised to prevent losses for bondholders. This protects bondholders’ economic interests, in Fitch’s view.

“Moreover, a majority of bondholders can prevent deferral by exercising veto rights. Fitch would treat deferral events that occurred against the wishes of a majority of investors as a default.”

Importantly though, Fitch said, “We view the ability to defer payments in certain circumstances within a fixed maturity as equivalent to making a change to the repayment schedule, making the bonds more resilient to the effects of natural disasters. This may support the ability of low-rated sovereigns to recover from natural disasters and give them flexibility to improve their payment capacity.”

Reducing the burden on countries that suffer major natural disasters is one of the key reasons behind sovereign catastrophe bond issuance.

Often when a major natural disaster strikes a country can still have a debt burden to pay, so the liquidity available from a cat bond can be an important source of capital for the government, for recovery and rebuilding, as well as purely recapitalisation in a time of possible crisis.

Interestingly, this new sovereign bond issue from Barbados also features a clause that enables payments to be deferred should a pandemic break out, another catastrophe sized event that can impact a countries ability to continue making payments to holders of its bonds.

The parametric break-clause on payments is also partly parametric in nature, given it requires a WHO declaration of a pandemic, or a significant health emergency, while Barbados would also need to be diverting significant sums to the emergency at the same time.

Grenada was the first to embed a hurricane clause in one of its sovereign bonds back in 2015, since when it has become increasingly common.

However, this is the first where we’ve seen the reporting agency aligned with a source of sovereign parametric insurance, as the issuer, Barbados, also uses CCRIF insurance protection as well.

Aligning triggers, or activation inputs, could be extremely helpful, as it means flows of capital can be more predictable, in terms of insurance recovery and stopping bond payments for a time, all of which can be beneficial to budgets.

Issuance of bonds with natural disaster related clauses embedded is expected to increase, as these are extremely valuable for the countries most exposed to catastrophes, severe weather and also climate change.

“Issuance of natural disaster clause bonds is widely predicted to increase in response to the rising number of extreme weather events being caused by climate change,” Fitch Ratings said.

Adding that, “The International Capital Market Association (ICMA), together with the IMF, lawyers and other interested parties, are developing a framework for debt-reprofiling features, which could be triggered by natural disasters.”

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