Mexico’s cat bond program set for shake-up or cancellation, as FONDEN to close

Mexico’s Fund for Natural Disasters (El Fondo de Desastres Naturales), more commonly known as FONDEN, is set to be dismantled along with more than 100 other government funded public trusts, as lawmakers in the senate voted to reform this area of public funding.

Lawmakers have railed against wasted public spending across the 109 public trusts being shuttered, in partisan action that led to protests in the government houses.

Driven by a desire to divert public spending to the economic recovery from COVID-19, public trusts that provide the funding for initiatives such as FONDEN are set to close and responsibility for these functions be passed down to local or regional actors.

It puts the future of Mexico’s sovereign backed natural disaster insurance financing in doubt, as well as the future of its long-standing catastrophe bond program.

Mexico has benefited from catastrophe bond coverage, facilitated by the World Bank alongside major global reinsurance firms such as Swiss Re, for many years.

Having first been the recipient of catastrophe bond protection as far back as 2006 with the CAT-Mex Ltd. transaction, Mexico’s natural disaster fund has repeatedly renewed its coverage from the capital markets through a series of World Bank supported arrangements.

These included the MultiCat Mexico 2009 Ltd. and MultiCat Mexico Ltd. (Series 2012-1) cat bonds, after which it shifted to use the IBRD issuance platform with the IBRD / FONDEN 2017 transaction, participated in the Pacific Alliance issuance with the IBRD CAR 118-119 deal in 2018 and most recently its largest $485 million IBRD / FONDEN 2020 cat bond in March 2020.

For most of these transactions, the trustee of FONDEN acts as the insured for the coverage, entering into an insurance agreement with the Mexican government-owned insurer Agroasemex S.A, who in turn entered into reinsurance agreements to secure the protection.

The FONDEN 2020 cat bond deal remains on-risk through March 2024, so has a way to run and provide its retrocessional reinsurance protection to the ceding reinsurance entity (Swiss Re) and cascade this coverage down to FONDEN’s benefit.

But with FONDEN now dismantled, it raises questions over the future of this outstanding catastrophe bond, as well as the future of the program itself.

The FONDEN 2020 cat bond could potentially be redeemed early, to halt any further payments that need to be made. The FONDEN trust will need to keep up its obligations under the terms of the transaction, or halt it entirely.

Which means the cat bond could put the shuttering of the FONDEN trust on hold, which of course could cause lawmakers to push for the early redemption of the cat bond notes.

However, with the World Bank supporting the issuance, it would seem prudent for the Mexican government lawmakers to keep the disaster insurance protection it provides in-force until they have established alternative routes to secure financial protection to support their disaster recovery needs.

An early redemption will also come with costs attached, so it may depend on just how determined lawmakers are to make a point over FONDEN, or whether they elect to allow the cat bond and its protection to run its course.

Going forwards though, how easy it will be to centralise disaster risk management and financing in a country now lacking a disaster fund, remains to be seen.

No doubt this will complicate the work of the World Bank in Mexico, as FONDEN has provided a central funding source against which protection from the catastrophe bonds could be structured.

With that now set to disappear, the future of this important cat bond program is now in doubt.

The vote in the senate was extremely close and partisan in nature, while an effort to save FONDEN and a number of other trusts almost succeeded it seems. But party differences over public spending in the wake of the pandemic appears to have killed hopes of saving FONDEN.

The bill to shutter FONDEN and the other public trusts now heads to the President’s office for signing. Lawmakers hope that the spending to be diverted from the trusts will go to the recovery from COVID-19, to support Mexico’s health and economic needs.