Grenada triggers a “hurricane clause” to suspend bond payments

The first triggering of a “hurricane clause” on government bonds by the Caribbean nation of Grenada has put the spotlight on efforts for more countries to suspend debt payments when natural disasters strike.

Grenada told investors this week in its $112 million bond that it would suspend $12 million in interest over the next year as it recovers from Hurricane Beryl, which devastated the outlying islands last month past.

The trigger of what was the world’s first disaster “break clause” when Grenada entered into its debt almost a decade ago will be a test case for the effectiveness of these tools. Even other small hurricane-prone island nations have largely held back from adopting similar clauses, despite growing encouragement from official creditors.

“Grenada gives us the opportunity to test the value of this contractual innovation in helping a country and its people recover from a devastating disaster, and this should not be underestimated,” said Shakira Mustapha, a research leader at the Center for Protection Against disasters.

At the same time, she added, there needs to be “clear articulation” of the tax relief brought by these clauses and also how their triggers are designed, given that hazards such as droughts or floods are harder to modeled than earthquakes or cyclones.

The breaks are seen as alternatives to what UN climate chief Simon Stiell called “endless debt cycles of governments borrowing to rebuild, only to face another climate disaster”, while reviewed the damage to his own home island of Carriacou in Grenada in July.

As hurricanes and other threats become more frequent and damaging, countries are often faced with costly emergency loans or insurance upfront payments as a result.

“Climate change is not insurable. The frequency of these events, once known as once-in-a-thousand-year events, occurs every few years. . . so it has to be different from insurance,” said Avinash Persaud, special adviser on climate change at the Inter-American Development Bank.

Dickon Mitchell, Grenada’s prime minister, said in July that losses from the first-ever strong storm of an Atlantic hurricane season could eventually amount to a third of the country’s GDP.

Countries from Mexico to Jamaica have also taken out insurance through investors buying catastrophe bonds arranged by the World Bank, but these are relatively complex and, in Jamaica’s case, not triggered in response to Beryl.

Grenada’s pause was activated after an insurance claim from the government exceeded a $30 million threshold that allowed it to suspend up to two interest payments.

“The interest saved is added back to the principal of the debt at the end. So, effectively, it’s a tap of liquidity at non-emergency rates. And it’s automatic (with) no need to go through an onerous process to try to get it,” Persaud added.

The World Bank is now offering two-year disaster breaks at no extra charge for new loans to island nations and other small economies, in one of the biggest official efforts yet to push through the clauses.

In a paper this month, the IMF also detailed how it will treat these clauses alongside other climate-related bonds when looking at countries’ debt sustainability. “The resulting reduction in the need to borrow against natural disasters would mitigate the impact of the negative shock on debt burden indicators,” the fund said.

Despite this, standstill clauses have so far failed to catch on in bond markets. After Grenada, only Barbados included provisions in international bonds, including restructured debt in 2018.

“It’s a no-brainer for issuers and bondholders, but it’s surprising that we haven’t seen wholesale adoption,” said Sebastian Espinosa, managing director at White Oak, a consulting firm that has helped Grenada restructure its sovereign debt since 2015. which added the hurricane clause.

“There have been calls for private sector lenders to include these clauses in their contracts, but that’s not how bond markets really work,” Espinosa said. “In fact, it is up to the issuer and its advisers to insist on them.”

In Grenada’s case, “the clause was accepted by bondholders in the restructuring because it makes sense for a small country like Grenada to have that flexibility,” said Carlos de Souza, portfolio manager at Vontobel, an investor in Grenadian bonds.

But other countries, including larger sovereigns, may be reluctant to put break clauses in their regular bond sales for fear of paying extra borrowing costs for triggers that may never be used, de Souza added.

Governments may have to test the waters, for example by issuing two bonds that are identical except for one that includes a break provision, he said. “Without this kind of counterfactual, it will be very difficult for a country to assess the true cost of issuing the clause.”

Those clauses shouldn’t cost extra because they limit how many times issuers can trigger them over the life of a bond, such as three times for Grenada’s debt, Persaud said.

The price of Grenada’s bond, which matures in 2030, fell slightly after Hurricane Beryl as investors weighed a possible trigger of the clause. Before Beryl hit, Grenada’s finances were improving. In June, the IMF estimated a budget surplus of 9.5% of GDP this year.

This was based in part on an increase in sales of Grenadian citizenship to investors who can use their passport to access US investment visas and visa-free travel to several countries. Bondholders also receive a portion of the citizenship sales as part of the restructured debt.

“From a financial perspective, they didn’t necessarily have to trigger the clause, but it was their right to do so and I don’t think anyone will criticize the trigger,” de Souza said.