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ESG Focus: Social Sovereigns; Aid Or Privatisation?

ESG Focus | Aug 02 2021

FNArena's dedicated ESG Focus news section zooms in on matters Environmental, Social & Governance (ESG) that are increasingly guiding investors preferences and decisions globally. For more news updates, past and future:

Sovereign Social and Sustainability Bonds: Aid Or Privatisation?

Big capital is encouraging sovereign social bond issuance as a means to achieving the UN’s Sustainable Development Goals, but everyone’s a critic.

– Sovereigns shy to enter the social bond market
– Government aid, or backdoor privatisation?
– Fledgling sovereign social bond market prepares to take flight
– Sovereign sustainability bonds last to fly the nest

By Sarah Mills

Sovereign bond issuance is an important plank in achieving the United Nation’s (UN’s) Sustainable Development Goals, and as such will be a prime destination for investors’ funds over the next decade and beyond.

But governments have been reluctant to play ball.

Reasons include geopolitics; lack of expertise and social bond frameworks; and general problems with social bond issuance, such as liquidity, fungibility, difficulty ring-fencing social assets, and finding monetisable programs.

FNArena’s previous article on green sovereign bonds addressed these reasons in more depth (see link below).

Even covid and the IMF’s disingenuous distribution of covid-response funds, which was weighted heavily towards wealthy nations (and which we discuss in the next article on sovereign covid-reponse bonds), has inspired only a trickle of activity.

Yes, covid did give a massive boost to issuance but it was off an abysmally low base.

According to ICMA, non-covid-response social bond issuance for 2020 totalled just $11.6bn to May 15 of that year.

And much of the sovereign social and sustainability bond issuance in the past 18 months has been covid-related, buoyed by some massive issuance from the European Union as part of its environment and jobs-related plan to “build back better”.

Nuts and bolts of social bond issuance

Sovereign social bonds deploy use-of-proceeds funds towards a range of social projects, which we examine in an upcoming story on the broader social bond market.

To qualify, the proceeds just need to finance or refinance social projects or activities that achieve positive social outcomes and/or address a social issue – preferably aligned with the UN SDGs. 

Once the market gains its footing, much of sovereign social issuance is likely to be tied to assets such as hospitals, public transport and public housing.

Theoretically, the sovereign social bond market represents an opportunity to drive improved social outcomes around the globe; while simultaneously improving productivity and absorbing global capital surpluses.

In theory, social bonds apply to populations such as those living below the poverty line, the marginalised, migrants, unemployed, women and/or sexual and gender minorities, people with disability and displaced persons.

In reality, nearly every form of government expenditure, with the exception of defence, could be defined as social and be a candidate for a social sovereign bond. 

Funds could be used for many other purposes such as wages and social security. 

For example, wages bills of large non-financial corporations are already often financed through the issuing of commercial paper in open markets.

Social impact bonds (SIB), in particular, target the care functions of the state, and many believe this function may one day be classed as the “care industry".

Ideally, their structure should comply with ICMA’s Social Bond Principles.

As with other GSS issuance, default is not triggered if the issuer fails to hit targets, the market relying on reputational pressure to ensure compliance.

Why the resistance to social bonds?

Social bonds, and social impact bonds in particular, are being billed as the next horizon to privatisation – a wolf in sheep’s clothing.

Critics argue that, similar to privatisation, private capital will monopolise the best assets for a song, further impoverishing governments and reducing their sovereignty.

These critics regard the social impact bond market in particular as an extension of neoliberalism and austerity in the social services sector through the financialisation of care – which is the state’s remit.

“At their core, SIBs are a more expensive, privatised financing model for services that could be finance publicly at a lower cost (like private health insurance),” says Policy Note.

Some perceive social bonds as a tax by big capital on participation in every field of human endeavour, including charity work and social services. 

Or, at the least, an attempt by big capital to control social spending and align it with its own imperatives. 

If so, it should be good for business – financiers in particular – but the jury is out on whether it is good for individuals.

If history is a guide, it probably isn’t – particularly for those without capital – but then history is not always reliable guide to the future. 

We discuss these issues in an article to come on social bonds.

Why introduce a middle man?

Given the tax base already funds social projects, by introducing a middle man into the funding equation a society is essentially paying a commission on top of normal social investment.

This is reminiscent of mandatory private health insurance, which simply pays an intermediary a premium for the provision of the same service. 

Then again, privatisation was rolled out despite strong opposition, so it is likely social-bond issuance will follow suit.

Sovereigns have long been issuing debt for general purposes through the treasury bond market; so one assumes premiums for social bond issuance would have to be sufficiently enticing to create a separate issuance – particularly when that issuance is linked to assets of considerable value.

Governments have been slow to issue bonds for social projects given social-service supply is part of the government remit from the tax base.

In some countries, social debt must be financed with tax, so there could be legal hurdles for these sovereigns. 

The above factors raise an interesting dynamic – different implications for developed and developing countries.

Wealthy governments can, by-and-large, easily fund its own social services without introducing a middle man.  

They already hold the existing infrastructure and the system is fairly efficiently geared to this end. 

The benefits of inserting a middle man are less, and they have more to lose.

Poorer countries seeking to develop highly functioning social services will likely have a greater need to tap the sovereign social bond market and potentially have more to gain as surplus global funds seek new destinations, mobilising productivity on the way.

Also, a sovereign social impact bond, or even a social bond, is more likely to be eligible if it is in the developing world given the impact quotient is higher. 

This dovetails neatly with the UN Sustainable Development Goals’ (SDGs’) focus on investing in poorer nations.

History is on the side of social sovereign bonds

The economics might not always stack up for governments but in the reality of the new world order, it may make sense.  

Governments are becoming increasingly impoverished and corrupted.

Financialisation can only be stopped through revolution or decree, and if a decree has been issued, it is in favour of financialisation, not agin it.

For example, privatisation occurred despite intense opposition.

Even if uptake is slow; big capital has crisis capitalism at its disposal to force the agenda (we discuss this in our article on covid-response bonds).

And sovereign social and sustainability bonds are useful for governments that have insufficient eligible green assets to issue a green bond.

Also, assuming social stability is truly an aim of big capital as outlined in the ESG and SDG agendas, their intent may be true.

On face value, that would weigh the scales against investors in the developing world; particularly passive investors, given the lack of transparency in these nations.

But win-win situations can be generated – the sweet spot from a risk perspective – and the onus is on investors and financiers to do their homework.

Besides, big capital wants these initiatives to work. 

The programs have been decades in the making; are linked to the green transition; and the scale of the ESG mandate speaks for itself.

Early sovereign social bond issuance

Given the parlous uptake of sovereign social bonds, much of the issuance documented below refers to covid-response bonds, which we cover in a separate article.

Sovereign social bonds were issued for the first time in 2020 by Chile, Ecuador and Guatemala – four years after the world’s first sovereign green bond was issued in 2016.

Ecuador was first of the rank, issuing the world’s first sovereign social bond in 2020, for affordable housing.

Republic of Guatemala issued a US$1.2bn sovereign dual-tranche bonds to finance or refinance eligible social investments directly or indirectly related the covid-19 prevention, containment and mitigation.

It was the first social sovereign bond in Central America and the Caribbean and the first Latin American covid-response bond.

Wealthy government and semi-government entities with established social bond frameworks also tapped the market.

The European Union emerged as the largest player to fund a jobs recovery program post-covid, which we cover in the covid-response bond article.

Australia’s National Housing Finance and Investment Corporation issued US$462m of social bonds in June. 

The issuance was more than two times oversubscribed; and yielded government savings of roughly US$80m over 12 years.

The bonds funded eight community housing providers (CHPs).

These included SGCH Group, Mission Australia, Unison, Common Equity Vic, Foundation, Pacific link, HCA SA and HCT).

The AAA-rated 12-year interest-only bonds to CHPs carried a coupon of 2.06%. 

Implications for investors

Social bonds are use-of-proceeds bonds tied to specific projects.

This gives investors the option to pick and choose how their “social” funds will be used, assuaging concerns over government incompetence and providing an opportunity support causes that interest them.

They also give investors an opportunity in some cases to secure funding against specific assets. 

The architects of the transition, for example, would have initially set their sights set on specific assets such as public housing, transport and hospitals.

But developing countries have far less existing infrastructure to secure debt against; and greater political instability.

Given the UN’s Sustainable Development Goals target investment in emerging economies, and given the rise of the blended finance imperative, large institutional investors with deep research pockets are being called upon to enter these markets to safeguard the new frontier for capital surpluses.

Sovereign social bonds also offer investors a new source of long-term returns. 

Where previously investors could rely on fossil-fuel income (and government fossil-fuel subsidies for returns), they will need to invest in renewable infrastructure and other social infrastructure to replace that revenue.

Given social funding is meant to be directed to building infrastructure and services in developing countries, it may offer investors opportunities to invest “off-the-plan” government infrastructure.

But political corruption or voter discord could prove problematic. 

For example, Mexico City Airport Trust issued a US$16bn green corporate bond, which was besieged after a referendum posed by a newly elected government halted construction.

The bonds underperformed by 200 basis points.

Investors were soothed after the government launched a buyback of US$1.8bn of the US$6bn, but the outcome could have been worse.

Sovereign bond projects, by their nature, would be particularly vulnerable to such vagaries. 

International Courts are likely to arbiter on this.

In terms of returns, The Journal of Fixed Incomes (JFI) says ESG is a material issue for sovereign bond investors, even after accounting for macroeconomic and credit variables. (See the previous sovereign green bond market story in the link provided below for more details).

Liquidity is obviously a problem in the market but so is fungibility.

A social issue for one government may be different for another, further dividing liquidity. Then there are credit ratings, currencies and lack of market standardisation.

The process for project evaluation and selection is fledgling and obscure.

Some turn to S&P Global’s Positive Impact Scorecard and toolkit, which aligns with SDGs and is linked to social outcomes and objectives, for guidance.

One assumes that as the market develops, more signposts will be forthcoming.

Sovereign sustainability bonds

Sovereign sustainability bonds (SSBs) are use-of-proceeds bonds issued for general purposes. 

SSBs represent a fraction of the total US$316.8bn (figures courtesy CBI) sustainability bond (SB) market.

Like sovereign social bonds, SSBs received a jumpstart from covid, but this was off an extremely low base.

The number of sovereign issuers rose just 5%, and many were wealthier nations with established sustainability bond frameworks ready to go to market. 

While the average size of instruments jumped 214%, the number fell -26%. 

The number of currencies fell -14%, suggesting a concentration in major currencies with liquid bond markets. 

The extent to which a sovereign might choose to issue a sustainability bond rather than a green or social bond would depend on need and pricing.

Many sovereigns are demonstrating a preference for sustainability bonds over social bonds, given their flexibility and access to the stronger market appetite for green issuance.

Demonstrating their faith in the market, many countries are jostling for pole position as trading centres and now offer sustainability bond exchanges.

These include Taiwan, London, Stockholm, Nasdaq, the International Stock Exchange, Nigerian Stock Exchange, and the Toronto Stock Exchange.

Early issuance

Mexico, Luxembourg and and Thailand introduced sustainability bonds in 2020.

Mexico issued the world’s first sustainable bond (E750m) linked to the UN’s SDGs.

Luxembourg issued Europe’s first sovereign sustainability bond through the Grand Duchy of Luxembourg, which has also been active in establishing exchanges for the green market.

Chile, an early entrant to the green sovereign bond market in 2016, has tapped the market; although sustainability bonds represent only 10% of the nation’s GSS issuance. 

Taiwan followed suit. 

Taiwan’s Formosa bonds dual-listed on the Taipei and London stock exchanges,. Boasting the lowest coupon on record, they mature 2053, suggesting considerable interest and faith in the nation’s future.

Peru is also preparing frameworks to tap the GSS market.

Sustainability bonds disguised as aid?

Ghana, meanwhile, plans to sell up to US$1bn of sustainability bonds this July, to broaden access to education and help refinance domestic debt for social and environmental projects, including the government’s free secondary school policy. 

Bloomberg notes the funds will help plug a budget gap, which is expected to hit 9.5% of GDP this, year, down from an 11.7% shortfall in 2020. 

The issue has been criticised for lack of additionality, given the government’s free secondary school policy was already in place; and because plugging budget gaps (similar to corporate working capital shortages) theoretically is not the aim of the game. 

But it’s early days and the uneven distribution of IMF covid-recovery funds to wealthy countries, which is then likely to be “donated” to developing nations, suggests this is considered satisfactory for now.

However, it may prove problematic for institutional investors depending on their fund’s guidelines.

Meanwhile, China has been accused of gaming the market, deploying sustainability bonds to its renewable energy assets under its new infrastructure plan as a build-back-better concept.

As a serious competitor in the renewable energy market, rival nations viewed this with some suspicion, but green investment is green investment.

Coming up

Our next sovereign bond article focuses on covid-response bonds.

Some observers suggest that these represent a new class of “emergency” or “crisis” bond, that stems from the phenomena of crisis capitalism, or “disaster capitalism”, a concept popularised by Naomi Klein in her book The Shock Doctrine – a harrowing but fascinating read.

Then it’s back to the standard GSS use-of-proceeds market, where we still have the social bond, sustainability bond, and social-impact bond to examine before hitting the sustainability-linked bond market. Enjoy!

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