Pattern Risk of the Securitized Biopharmaceutical Mega-Fund

Abstract

Clinical-stage biopharmaceutical companies are constantly challenged to raise sufficient capital to advance the development of the drug projects in their pipelines. The risk of capital becoming too costly or unavailable when it is needed can constrain the development and commercialization of important medical advances. Securitization has been discussed as a way to increase the flow of capital to clinical-stage biopharmaceutical companies. For securitization to draw more capital into funding biopharmaceutical development, a technique for allocating the current and future cash flows associated with specific biopharmaceutical products must be developed. Fernandez et al. (2012), Fagnan et al. (2013), and Fagnan et al. (2014) have proposed a “mega-fund” scheme as the foundation for a clinical stage biopharmaceutical securitization structure. The securities issued to finance the “mega-fund” are called “Research Backed Obligations.” In this article, the authors modify their label by calling the securities structured biopharmaceutical-backed bonds (SBBBs). This model of the flows of cash through the SBBBs illustrates that it is not only the final number of projects that succeed that drives the value of the fund; also important are the timing of failure, the probability of failing in each phase of development, and the magnitude of success in each phase. TOPICS: Legal and regulatory issues for structured finance, fixed income and structured finance Key Findings • The pattern of drug development failure across the three phases of FDA clinical trials drives the portfolio value of the Biopharmaceutical Mega Fund. • Incorporating licensing/royalty agreements between clinical stage biopharmaceutical companies that are developing the drugs that compose the biopharmaceutical mega-fund and commercial stage biopharmaceutical companies into the securitization program will alleviate adverse selection issues that could depress the value of the securities issued by the mega-fund. • Pattern risk is the uncertain path of progress through the clinical stages of testing that the assets in the biopharmaceutical mega-fund follow. This risk can be managed by engineering the structured biopharmaceutical-backed bonds to account for variations in the patterns of clinical failure.