CSFB’s cancellation bond for Fifa last month proved that the capital markets are increasingly willing, and more than able, to absorb risk traditionally taken by the insurance sector. Geraldine Lambe reports on this idiosyncratic issue.
Football. It may be The Beautiful Game but it is also big business,
with billions of dollars worth of sponsorship and television rights at
stake if the event is cancelled. It was with such risk in mind that
Credit Suisse First Boston brought a new asset class to the capital
markets last month.
In a twist on the catastrophe bond, the $260m “cancellation bond” from
world football’s governing body Fifa is the first ever in which bond
investors have taken on the risk of a man-made disaster – primarily
that of a terrorist attack – in a binary loss scenario.
Origins in 2001
The genesis of the bond lies in CSFB’s securitisation of marketing
rights for the 2002 and 2006 World Cups carried out for Fifa in 2001,
CSFB’s earlier “hail bond” and the changing dynamics of the insurance
market.
In January 1997, CSFB completed a transaction in Switzerland to
transfer the risk of single hail or other storm damages on motor
vehicles into the capital markets. It was the first large transaction
selling insurance risk to the public. Jean de Skowronski, managing
director and head of Swiss debt capital markets, says it opened up all
sorts of possibilities for the team. “It proved there was an
opportunity to transfer easy-to-understand insurance risks into the
capital markets,” he says.
However, the market was not quite ripe. “We had discussions with a lot
of potential issuers in all sorts of industries, including Fifa. But at
that time the insurance market was very competitive in terms of pricing
and there was more than enough capacity to absorb most of the risks,”
he says.
That was all changed by 9/11. In the aftermath of the World Trade
Centre atrocity, insurer AXA first demanded to renegotiate its cover
for Fifa and then publicly pulled out of its contract in the middle of
the last World Cup. This unexpected decision left Fifa in an awkward
position because all its agreements with sponsors stipulated that the
championship had to be insured. It did, however, pave the way for
alternative solutions.
Comparative study
What ultimately clinched CSFB’s strategy to execute into the
capital markets was an extensive study carried out with Fifa before the
deal, to compare the outcomes of a capital markets solution versus an
insurance-based solution.
“It revealed that the insurance market was offering terms that did not
meet Fifa’s objectives, with the industry shifting from multi-year to
annual renewable cover. Additionally, the negative experience with AXA
suggested a capital markets strategy was preferable,” says Lee
Rochford, co-head of the European asset-backed securities (ASB) group.
The structure of the bond took about six months to evolve and it had to
strike a delicate balance between Fifa’s requirements and investor
appeal. The starting point was the basic principle that all risks
should be covered, with two exceptions: the outbreak of a world war and
a boycott by players or participating associations, in which case the
investors would be repaid.
“Essentially, we were trying to replicate pre-9/11 insurance conditions
in a post-9/11 environment,” says Andrew Pearse, vice-president in the
European ASB group. “But the only tools we had were those used by Fifa:
that is, the potential to relocate the matches or reschedule the
competition. We were, therefore, pretty restricted in terms of how we
could structure the bond conditions.”
The mechanics of this unusual transaction are worth explaining. Golden
Goal Finance Ltd, with co-lead manager Swiss Re Capital Markets, issued
in four tranches: $10m fixed and $210m floating rate notes (FRNs), a
E16m floating rate and a CHF30m fixed rate tranche. The notes have
expected maturity on September 30, 2006, and legal maturity on December
30, 2009. It is not until January 1, 2006, that investors begin to bear
the risk of an event taking place that leads ultimately to a
cancellation – a key differentiation from a normal catastrophe bond.
Key dates for the season
The next key period is that between June 9 and July 9, 2006, the
scheduled period for playing the championship. If it cannot be carried
out between those dates then the bond terms decree that Fifa must
reschedule or relocate the matches (if Germany withdraws from hosting
the event). The earliest date at which the competition can be cancelled
is March 2007, and the earliest date at which the bond’s beneficiaries
can profit is January 2008.
If the World Cup is not completed before August 31, 2007, 75% of
investors’ principal will be lost but, as an unusual appetiser, the
amortisation profile returns 25% of investors’ principal in a single
bullet payment in December 2005 – six months prior to the start of the
tournament.
Besides the structure, key elements in the success of the transaction
were the risk profiling and generous pricing. Given the nature of the
principle risk, CSFB used a “logic tree” approach; this asks a series
of qualitative and sequential questions, such as: is the World Cup a
likely target for terrorists? What would be the likely form of an
attack? Could it be prevented? Would such an attack force Fifa to
relocate and, if so, could it do so in time? After attributing scores
to each potential risk, the firm calculated just a five basis point
(bp) probability of cancellation, equating to a very low risk for
investors.
The unique nature of the event and the organisation also meant that
there was a strong alignment of interests between Fifa and bondholders.
The bond covers Fifa for $260m, while its total exposure is $1.7bn;
$1.2bn of that is for broadcasting rights, which Fifa is not required
to insure. If Fifa cancelled, it would have to repay all the money it
is paid in advance of the event – amounting to 60% of event revenues.
And, politically, it would be a disaster for the World Cup to fail.
“It is almost impossible to imagine that Fifa would cancel,” says Mr
Pearse. “It is a single product company and 90% of its revenues come
from the World Cup. These are intellectual property revenues so if the
name becomes tarnished, the value is diminished.”
Similarly, says Mr de Skowronski, Germany’s commitment to hosting the
competition is a strong risk mitigant. “This is one of the sporting
industry’s premier global events and it is highly unlikely that Germany
would withdraw its support.”
The low risk profile helped the bond gain an A3 rating by Moody’s –
which is regarded as pretty high for a transaction in which principal
is at risk. The bonds were priced at par to give spreads of 150bp over
Libor (dollar FRN) and Euribor (euro FRN).
“There were few comparables,” says Adrian Carr, managing director and
head of European ABS syndicate. “We looked at where asset-backed
securities were trading and also to insurance market pricing to decide
where we should begin marketing.” The coupons for the fixed rate
tranches were set at 3.895% for the dollar bond and 2.851% for the
Swiss franc issue.
Attractive traits
The issue was immediately attractive to investors because of the
diversification it offered, the attractive spreads (especially for a
single A rating) and the low risk profile, but the idiosyncrasy of the
bond did lead to a few challenges. “Many interested investors were
prevented from participating because of portfolio restrictions – they
have no allocation for ‘cancellation’ bonds,” says Mr Carr. “The bond
does not lend itself to traditional credit analysis, so going through
credit committee was different than usual, often requiring board
approval. Still, 70% of the buyers were banks,” he says.
That said, it was not a difficult sell by any means – the execution was
fairly rapid; marketing began on September 1 and the deal was closed by
October 8, having been up-sized by $10m.
A big incentive was clearly the risk period relative to the return.
“Investors don’t go on risk until January 2006, so the window of
exposure is only seven months, versus three years’ return,” says Eve
Flotron, director in ABS syndicate. Annualised, the risk premium is in
excess of 11% over Libor. “So the risk-reward analysis is very
compelling compared with anything else in the market.”
The market agrees that Fifa got good value for money with this
transaction – as well as no counterparty risk and more certainty than
it would have with an insurance contract. So, will it turn to the
capital markets for its next event? “Fifa is always open to innovative
solutions,” says Mr Pearse.
The transaction has also garnered a lot of attention from other
potential issuers, says Mr Rochford. “People are very interested to
find an alternative to the insurance market,” he says.