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.

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