Investor demand, bolstered by Covid-19 concerns, have kicked off a global surge in social bond issuance.
Social bonds have lately been bringing a shine to the “S” in ESG (environmental, social and corporate governance) investment. Globally, $84.5 billion worth of social bond issues were recorded between January and September, accounting for almost one-quarter of the sustainable bond market (comprised of green bonds, social bonds, and sustainability bonds, which blend green and social). That compared with only 6% during the first nine months of 2019, according to Refinitiv.
While government entities like the European Commission still account for much of the social bond activity, nonpublic issues have become more prominent. At the end of October, Citi announced the largest-ever social bond offering from a private sector entity, a $2.5 billion affordable-housing issue.
In the Asia Pacific region, social bonds, whose proceeds are used to fund socially useful projects such as hospitals, schools and affordable housing, outraised green bonds last year.
“Growing issuance of social bonds is a topical issue for this year,” Mana Nakazora, chief ESG strategist at BNP Paribas in Japan, said in an August S&P Global report on the region.
Covid As Catalyst
How to explain the dramatic uptick? “Covid-19 played a key role in driving the strong increase in social bond issuances,” says Viola Lutz, associate director and head of Investor Climate Consulting at ISS ESG. Not only to finance projects in the healthcare sphere, she explains, but also in the economic arena, such as bonds to help preserve jobs in pandemic-afflicted regions.
“A significant proportion of social issuance during 2020 has been Covid-related,” agrees Kevin Ranney, director of Sustainable Financial Solutions at Sustainalytics, an ESG rating and analytics firm. “The pandemic has spawned use-of-proceeds criteria not previously seen in the market, related to prevention and the health impacts of the crisis as well as to the socioeconomic impacts of the crisis.”
The shift to social bonds is likely to have legs. “The pandemic is a driver, clearly,” says a senior banker at Spain’s BBVA. But even after the pandemic abates, “social bonds will have more traction. They will end up closer to green bonds” in their share of the sustainable bond market.
Changing investor priorities are partly responsible for the shift, some close observers say. Before 2020, most ESG investors sought bonds with an environmental focus, says Lauren Kashmanian, senior portfolio manager at Parametric. “Now with rising consciousness around social-justice issues, especially concerning equality and human rights, there has been a shift toward investor interest in bond issues with an acute social benefit as well,” she says.
The demand appears to be global. “We have seen substantial growth in the Americas—North and South—as well as Europe and Asia,” says Ranney. In October, the European Commission issued a €17 billion social bond “to help protect jobs and keep people in work.” It was oversubscribed thirteenfold.
The corporate market is gaining heft as well. The two largest corporate issues of social bonds during the first nine months of last year were Bank of America ($2 billion in proceeds) and IDB Trust Services (Saudi Arabia, $1.5 billion), according to Refinitiv. Then came Citi’s four-year non-call, three-year fixed-to-floating-rate note issue, with proceeds to finance construction, rehabilitation and preservation of affordable housing for low- and moderate-income populations in the US. Mitsubishi UFJ Financial Group, CaixaBank and UK fashion house Burberry, among others, have also issued social or sustainability bonds over the past year.
One reason social bonds have been slow to catch on until now may be that they are relatively labor-intensive. Issuers are expected to adhere to a framework of Social Bond Principles (SBP), and most report to investors regularly on project impacts. Many invite third-party reviews.
“It is key to have an external review,” says Lutz. For private sector issuers, she adds, “demonstrating the credibility of their social approach has been a challenge. External reviews are especially relevant to them, to create a narrative around their social commitments.”
The larger question that arises with sustainable bonds, including social bonds, is whether investors will willingly give up personal pecuniary gain to finance projects with positive social outcomes. “Right now, there is no price differential for green or social bonds versus standard bonds by the same issuer,” says Kashmanian. But “as investor demand grows, we may see lower yields for green- or social-labeled bonds. We believe investors will be willing to give up some yield in order to invest in bonds that align with their social values.”
Social bonds, and the demand for them, may be more resilient than traditional bonds in the face of market shocks, “so in the future they may have some price advantage in the secondary markets,” says the BBVA senior banker. When BBVA placed a €1 billion Covid-19 social bond in May, it was oversubscribed by nearly five times, and more than two-thirds of orders were from investors with ESG criteria, suggesting they were owning for the longer term.
While it is commonly thought that social bonds carry more credit risk, “this is a widely held myth,” Kashmanian argues. “As we have seen this year with the outperformance of many ESG-focused funds, investments that consider environmental and social factors can actually improve investment results over time.”
The downside risks may be more reputational than financial. As noted, issuers are expected to report regularly on projects, says the BBVA banker, and confidence could be shaken “if you used the wrong methodology [to measure impacts] and then have to correct it publicly.”
Role To Be Determined
The Inter-American Development Bank (IADB) issued its largest-ever sustainable development bond in April. Laura Fan, head of funding for the Treasury Division at the IADB, says that this year’s surge in social bond issuances was driven by a heightened awareness of social issues—ranging from income inequality to healthcare availability to tech accessibility—raised by Covid-19. That awareness, she adds, “will not disappear overnight.”
“Social bonds are here to stay,” Lutz agrees. “A broad set of issuers, including corporates, are aware of and feel comfortable with the instrument and will continue to use it.”
How big a presence social bonds will carve out for themselves isn’t yet clear, says Daniel Tortorice, assistant professor of economics and accounting at the Massachusetts-based College of the Holy Cross and co-author of a paper on the topic, “A Theory of Social Impact Bonds.”
“They have a 10-year history and solve legitimate problems,” Tortorice says. “The big question is if they can be standardized in a way that will allow the market to take off, or if they will remain a niche investment that must be negotiated between an investor and government [or other issuer] every time they are used.” Niche or no, he thinks social bonds will continue to appeal to investors.