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ESG Focus: Covid Heralds Advent Of ‘Crisis’ Bonds

ESG Focus | Aug 11 2021

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Covid Heralds Advent Of "Crisis" Bonds

Governments have been slow to adopt sovereign crisis bonds, but covid has proven a shot in the arm, if not without controversy

– Covid jump-starts sovereign bond market
– Introducing covid-response bonds
– Crisis capitalism and the new “emergency” or “crisis” bond

By Sarah Mills

The global sovereign green, social, sustainability (GSS) issuance has lagged private issuance, with governments expressing a clear preference for standard debt instruments.

But covid has triggered a rethink among many countries.

Reduced tax revenues combined with additional spending sparked a surge in sovereign borrowing globally as debt-to-GDP ratios soared.

The global risk-off environment witnessed a reversal of capital flows, leaving non-investment-grade issuers vulnerable.

Wealthy countries were in a strong position to tap private markets but emerging economies struggled. 

Unlike households and small businesses, developing countries have been slow to receive debt relief from private creditors, in some cases leading them to test the fledgling covid-response bond market.

The G20 did, however, offer to suspend debt service payments owed by 73 low and lower-middle income countries, as did many private creditors.

The Organisation for Economic Co-operation and Development’s (OECD’s) Sovereign Borrowing Outlook for OECD Countries notes that OECD governments borrowed US$18trn in 2020 in response to the pandemic, compared with US$6.8trn the previous year.

The OECD forecasts this will rise to US$19trn for the 2021 full year.

The OECD reports that about 30 mostly non-investment grade countries experienced 68 downgrades in 2020.

The OECD reports that overall sovereign debt issuance fell in 2020, but developing countries and emerging economies issued US$3.4trn in debt in 2020 – up 35% on the previous five-year average – reflecting on the downgrades and reduced global risk appetite.

The bulk of these borrowings were raised through vanilla debt mechanisms (particularly short-term debt), not the GSS market.

But the OECD suggests that many might choose to refinance into new securities that rebalance their issuance towards longer-dated instruments. 

Downgrades, combined with reduced risk appetite and covid-related spending holes, have left highly leveraged emerging markets increasingly vulnerable to an upswing in US interest rates. 

Such an event would trigger a reversal of capital flows and currency depreciations, tipping some into financial crisis.

The OECD notes that new instruments like covid-response bonds can be useful to moderate the exchange rate, interest rate, and rollover risks of debt portfolios, depending on the maturity and currency.

Covid jump-starts sovereign GSS bond market

As a result, some are hailing covid-related bonds as the biggest innovation in the social bond market.

Covid certainly gave sovereigns every reason to test the water; and a small few did. 

Clifford Chance points to issuance from China, Indonesia, Guatemala and the EU.

China, one of the wealthier nations, took good advantage of the covid-response offering. 

China was the first sovereign to tap the market, issuing a “covid-19 impact alleviation social bond” – the first aimed at preventing and alleviating unemployment stemming from the pandemic

Europe’s public and private sectors issued covid-response bonds, as a subset of their social and sustainability bonds.

The EU, in particular, issued bonds tied to green projects as part of its  “build-back better” campaign.

The mysterious nature of covid-19 bonds

There is no clear definition of a covid-response bond nor regulation.

The bonds can be used for either green or social purposes, given the creation of green jobs is perceived as generating a social benefit. 

Covid-response bonds have been issued either as general-purpose bonds or use-of-proceeds bonds.

This article focuses on the sovereign use-of-proceeds market.

Sovereign use-of-proceeds issuance is generally structured as either social bonds or sustainability bonds, while simultaneously bearing their covid-response label.

To date, sustainability bonds have proved the most popular.

Sovereign appetite tepid

Emerging economies have received every incentive to tap the covid-response bond market, including being starved of covid-relief funding.

And yet emerging economies have hardly rushed to the market.

Yes, covid-response debt has been more popular than standard sovereign social and sustainable issuance, but detractors attribute this more to desperation than desire.

Nuts and bolts of covid-response bonds

Covid-response bonds rely on the four key components of the social bond principles of the ICMA:

– use of proceeds for projects with social benefits;
– a process for project evaluation and selection;
– management and tracking; and
– reporting on use of proceeds.

A covid-19 bond must clearly identify the causes and the consequences that are being addressed. 

Use-of-proceeds causes could include medical equipment, unemployment, social loans for target populations, environmental projects, or revival of tourism, among others.

Many governments used their existing GSS bond frameworks for covid-19 response bonds and some established bespoke response bond frameworks, which generally hold the same principles.

Guatemala, for example, issued covid-response bonds through its social-bond tranche.

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

It was first social sovereign bond in Central America and the Caribbean, and the first Latin American covid-19 response bond.

Many governments without social bond frameworks have issued them as “coronavirus-related” bonds.

Mexico issued the world’s first sustainable bond (E750m), linked to the UN’s sustainable development goals (SDG). Ecuador issued the world's first sovereign social bond (US400m) to fund affordable housing. Given the timing of issuance, it is reasonable to label both in the covid-response category.

The term social bond can only be used if the bond complies to the International Capital Market Association’s (ICMA’s) Social Bond Principles (SBP); ditto for sustainability issuance, which must comply with either or both of ICMA’s social or green bond principles.

Covid-response bonds are expected to have a life beyond lockdowns as governments are likely to face a broad set of covid-related challenges and projects that change with time.

Coronavirus social bond issuers can also take advantage of reduced or waived fees on the Luxembourg and Nasdaq exchanges; which are focussing on developing sovereign ESG bond markets.

Complying projects

As with all GSS bonds, issuers must identify the intended use of proceeds, and communicate monitoring and impact reporting procedures.

There is no prescribed list for projects but the International Finance Corporation guidelines suggest three common themes: research and development for tests; vaccines and medications; loans to small businesses; and the production of health and safety equipment and hygiene supplies.

Not all proceeds need to be directed to coronavirus projects; they can be diverted to eligible social and sustainable projects. 

Given the potential for greenwashing and misuse of funds, surpluses are expected to be deployed to other social projects.

Such projects might include payment for social security expenditures and increased healthcare service capacity.

Purposes might also include lending to the financial sector to support businesses and companies impacted by covid; finance to infrastructure companies to soften the impact of supply and demand disruptions; or financing to large companies in the medical equipment and healthcare sector.

ICMA ruled that government guaranteed loans can be included in covid-19 bond-issuance by banks, opening the market to financial institution groups.

For bonds with maturities beyond 10 years, issuers are often required to clarify how these proceeds will be used post covid.

Crisis bonds – a new asset class? 

Covid has drawn attention to opportunities to link GSS bonds to social crises.

Specifically aimed at mitigating social problems arising from lockdowns and quarantines, covid-related bonds represent the first of a new type of social bond aimed at generating liquidity during times of global emergency.

Many are now discussing the potential for covid-response bonds to set a template for a new “crisis bond”, that sovereigns can adopt as needed.

Supporters say such a bond may mitigate currency-reversal risks as noted above.

Use-of-proceeds crisis bonds might also address the transparency concerns that have dogged previous debt relief and loans to nations in times of emergency.

In particular, proponents hope to link debt-relief to smaller nations to use-of-proceeds and sustainability-linked issuance, to both fire investment in the transition and gain greater control of the way in which nations distribute funds.

Emergency/crisis bonds have proved profitable for investors

When it comes to an investment opportunity, crisis loans of all shapes and sizes have a strong track record.

Covid-related bonds are no different. Here we primarily examine private issuance given the relative dearth of sovereign issuance.

FT notes the record issuance of emergency bonds, in the more established private markets, has been good.

Bonds issued by some of the companies hit hardest by coronavirus rallied sharply over the following year, providing a windfall for investors as economies recovered.

US high-yield bonds (beneath investment-grade bonds), returned more than 23% to investors in the year to March 20, notes FT – only the third time in history that the rolling 12-month return for the market has exceeded 20%. 

The GFC and dotcom crash were the others.

“In total, more than US$6trn of investment-grade debt, accounting for over 80 per cent of the outstanding, trades above US100 cents on the dollar, according to an index run by ICE Data Services,” says FT.

“In the US$1.5tn US high-yield bond market, the number is just slightly lower at 79 per cent of outstanding.” 

In contrast to sovereign nations, investors have also amassed record profits collecting public debt repayments through the pandemic.  

Recipients can redeploy the funds to wages and other forms of covid mitigation.

But no one is watching and there is little stopping companies from redeploying funds to purchase cheap assets or pay dividends, buy back shares, or anything else that takes their fancy.

Crisis bonds have precedents

Various crises have in the past led sovereign nations to experiment with debt designed for temporary economic support.

During the GFC, Norway introduced a government bond fund (GBF), which operated for several years before being wound down.

Other governments had similar instruments in place.

Norway reintroduced the Government Bond Fund during the early weeks of covid to help Norwegian companies access liquidity. 

The Norwegian government handed its management to the professional investment manager which manages the Government Pensions Fund Norway.

A Government Bond Fund is a pooled investment vehicle that invests primarily in bonds. 

By the end of 2020, the fund had invested in 90 loans issued by 66 different companies. 

It was a general purpose sovereign issuance rather than a use-of-proceeds issuance; but is indicative of the way in which many sovereign nations, even wealthy nations, have repeatedly been forced to the debt market for support during crises.

Use-of-proceeds issuance simply ties that debt to environmental and social outcomes, which is not necessarily a bad thing.

Critics of crisis capitalism not so sure

From a sovereign perspective, however, use-of-proceeds funds reduce a government’s flexibility in distributing funds. 

Critics of “crisis capitalism” advise caution on sovereign debt of all distinctions, given global crises are easily engineered, and big capital has been doing so with impunity for the past few decades, thanks to the financial chains and military power at its disposal.

These observers also recognise the potential of climate finance to fall under the “crisis” category.

Cogitatio defines crisis capitalism as: 

“…the way a neoliberal and colonial rhetoric of resilience is used to normalise an ongoing state of crisis and response,” says Cogitatio’s Joshua Long.

“There is a long history of framing disaster or crisis as a rhetorical antecedent to exploitative policies, but by the end of the 21st century, it had become remarkably commonplace in policy discourse,”

“The next two decades will determine if the design, funding, and implementation of climate projects and policies emerge in a just, democratic and equitable manner, or if they materialise in a political economic landscape of profit, polarisation and segregation,” says Long.

Protection for sovereign nations vs investor protection

Critics of crisis capitalism note the ease with which wealthier countries can and do impose crises on smaller countries.

Eurodad – a network of 60 civil society organisations from 29 European countries — decries the lack of transparency in the covid-response bond market.

Turning the transparency issue on its head, which usually focuses on investor protection by demanding greater disclosure from issuers, Eurodad calls for greater transparency from investors, adding another component to the disclosure debate.

In an article titled Sleep Now In The Fire: Sovereign Bonds and the Covid-19 Debt Crisis, Eurodad argues the case for:

– public registry systems for loan a debt data, including full disclosure of information on sovereign bonds;

– improved regulations for disclosures of bond contracts and holdings by underwriters and investors such as investment banks and hedge funds; and

– the adoption of a statutory approach for private creditor participation in debt relief under a multilateral sovereign debt workout mechanism.

Eurodad argues the latter is essential “to address the structural power imbalance between creditors and debtors and provide a level playing field for equitable debt resolution that places human rights at the centre of the multilateral response.”

Such measures might go some way to attracting sovereigns into the market, but they are unlikely to seriously redress the structural imbalances between nations.

“Despite their status as public contracts, there is a substantial lack of transparency when it comes to the terms, clauses and participants in bond markets,” notes Eurodad.

Meanwhile, the OECD recently launched a Debt Transparency Initiative to collect, analyse, and report on debt levels of low-income countries.

The initiative aligns with the Institute of International Finance’s Voluntary Principles on Debt Transparency and aims to remove the veil over bilateral lending to low-income countries.

This should provide a clearer picture of indebtedness and global debt relations.

IMF activity disingenuous but perhaps necessary

Crisis-capitalism critics also notes the International Monetary Fund (IMF) has been far from impartial in its distribution of covid-relief funds.

Even The Economist notes that, since the onset of covid, the IMF lent roughly US$130bn to 85 countries and provided debt-service relief to a few poor economies.

The magazine suggests this was rather stingy, given the IMF’s balance-sheet capacity rose to US$1trn after the GFC.

In July, the IMF did decide to create US$650bn in new foreign-exchange reserves for special drawing rights (SDRs).

But the funds will be allocated in proportion to the funding that countries provide to the IMF, meaning wealthy countries will receive more than 50%, and low-income countries just 3.2%.

Wealthy countries are planning ways to donate their allocations to poorer countries, some of which have been redirected to the IMF, helping the agency drip-feed no-interest loans to poor countries for the past year.

“The plan does not involve direct lending to countries, nor draw on the IMF’s balance-sheet,” writes The Economist

The SDRs are valued against a basket of several major currencies; and can be swapped for those currencies if the need arises.

There are no conditions attached to the use of such funds; the associated interest rate is roughly 0.05%; and there is no deadline to repay the loans.

Investors decry the moral hazard involved in such terms.

Others perceive it as a cheap way to keep a financialised system afloat and maintain global dominance: a charitable donation now from wealthy countries representing an investment in future leverage over poorer countries.

Wealthy countries could conceivably choose to dedicate those IMF funds to GSS lending to emerging economies, corralling them into the GSS market.

“Whether countries draw on it or not, the extra reserve cushion should lift market confidence and reduce the risk that a draining away of foreign exchange leads to balance-of-payments crises,” notes The Economist.

But it is a delicate balance given the IMF estimates the global economy is likely to face a shortage of reserve assets between US$1.1trn and US$1.9trn, which may be critical if the recovery triggers higher US interest rates.

Again, uptake of sovereign covid-response funds has been tepid, despite the delay in emergency funding. 

It makes financial sense for smaller sovereigns to hold out for low-interest, low-obligation, flexible SDRs; or even general-purpose funds (although the latter would depend on the premium, currency and funding costs given oversight at present, is negligible).

SDRs are more opaque than use-of-proceeds bonds and The Economist notes that unsavoury regimes can benefit unless sanctions stop them from converting SDRs to US dollars to repay debt. 

Sovereign nations already in debt can use SDRs to delay debt repayments rather than direct them to covid-response and mitigation, or social or green investment.

Or, heaven forbid, insolvent countries may use IMF cash donations from wealthy countries to pay off rival Chinese or Russian creditors.

So the agenda remains to help smaller nations through more transparent and targeted forms of debt.

Coming up

Well, that now concludes our introductory series to the GSS sovereign bond market.

Our next articles will cover the social and sustainable use-of-proceeds bond market, concluding our introduction to the broader GSS fixed-income use-of-proceeds market.

Our last articles on ESG finance will be dedicated to the fledgling sustainability-linked market, which will be coming soon to banks, financial institutions, corporations and neighbourhoods near you.

Sustainability-linked finance is set to become so ubiquitous that bankers’ new mass-market refrain could be: would you like fries with that?

Previous articles:

Transition Bonds — The Great Controversy (

The Sovereign Bond Dilemma (

Social Sovereigns: Aid Or Privatisation? (

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