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ESG Focus: Social And Sustainability Bonds

ESG Focus | Aug 20 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:

ESG Focus: Social And Sustainability Bonds

As the green transition and fourth industrial revolution spawn massive social disruption, two new types of bond have been developed to “save the day” – the social bond and the sustainable bond.

-Vehicles to serve the S in ESG
-A matter of principles
-The geopolitics of social bonds
-Sustainability bonds may dominate

By Sarah Mills

This final article in our green, social and sustainability (GSS) use-of-proceeds bond series covers the social and sustainability bond market.

Billed as the saviours of the society and the common man from the impending disruption spawned by the green transition and fourth industrial revolution; social and sustainability bonds are among the more novel financial concepts hitting the market.

The reality is more nuanced and FNArena examines their implications for investors and geopolitics.

We will save our examination of a related use-of-proceeds bond type – the social impact bond – for the final instalments of our series on impact measurement.

Show me the money

Of all the ESG investment opportunities, social investing has drawn the most cynicism from investors.

Investments in health infrastructure such as hospitals and education are more easily graspable concepts, but how does one monetise often not-for-profit social care?

Enter ESG finance.

Even before the pandemic hit, a report by the Business and Sustainable Development Commission estimated that achieving the United Nation’s Sustainable Development Goals (SDGs) could open up $12 trillion of market opportunities in food and agriculture, cities, energy and materials, and health and well-being, while creating 380 million new jobs by 2030.

In one sense, meeting the SDGs can be viewed through a wealth-distribution lens – big capital has achieved one of the greatest transfers of wealth in human history, and it may have to put some back just to keep the capitalism ball rolling.

But if this is the case, it is going to be extremely selective and strategic about how it distributes this largesse. 

Through this strategic lens, the SDGs appear to represent something of a business proposition – a form of privatisation of the social remit, and a vehicle for building secured social infrastructure in developing nations – the next frontier for financialisation.

A third lens views social impact bonds (a particular type of social bond) as a backdoor neoliberal tax on the care and general social functions of the state:

“At their core, SIBs are a more expensive, privatised financing model for services that could be financed publicly at a lower cost,” writes Policy Note.

Perhaps sustainable and social bonds can be viewed through all three lenses – a financial instrument aimed at pursuing social as well as financial value that can play a critical role in fostering growth and progress in developing Asia while further financialising the care industry and a risk redistribution mechanism. 

This is the lens we adopt for this article.

Through this lens, the ESG investment philosophy elevates values rationales (financial decisions grounded in moral judgment) that rival that of the traditional value rationale (solely basing financial decisions upon financial metrics).

Within this new investment paradigm, managing ESG risks translates to superior returns but investors will need to understand the rules of the game.

What is a social bond

Social bonds are blended-finance use-of-proceeds instruments that deploy capital into social endeavours such as improved health to education to employment.

The Asian Development Bank complains that most ESG investors don’t understand the value of ESG social bonds, and gives an example: 

A transport company could issue social bonds to upgrade transport and then pass the costs on to passengers. 

In the past, the transport company had to pay for the upgrades itself, the cost of which is also generally passed on to consumers and taxpayers, and if that failed equity investors bore the risk. 

Now the transport company can pass those capital expenditure costs away from equity investors to social bond investors at possibly a lower cost of capital.

If the investor chooses wisely, everyone wins. 

If it fails, well a lot would depend on collateral agreements and bond covenants.

A benefit of social bonds is that they offer a vehicle that can be used by a range of investors, boosting liquidity and fungibility of certain bond types across industries, increasing the “social” industry’s access to capital while offering investors a vehicle to invest in a country’s future or causes that interest them.

Corporations and private investors constitute one group, as outlined above.

Philanthropic investors can also invest in providing concessional working capital loans and guarantees of principal to help reduce the risks and costs of social bonds for issuer and investors. 

Multilateral organisations such as development banks and sovereigns can also either issue or invest in the market.

Smorgasbord of potential projects

Investors and issuers are spoilt for choice when it comes to eligible projects under the International Capital Markets Association’s (ICMA) Social Bond Principles.

Nearly every form of government expenditure, with the exception of defence, could be defined as social.

Mooted social projects include:

– public housing;
– lending;
– student aid;
– affordable basic infrastructure – which also falls under the sustainability bond banner (such as clean drinking water, sewers, sanitation, transport, and energy);
– access to services such as education and vocational training, health care, financing;
– financial services; 
– affordable housing; 
– employment generation and programs designed to prevent and/or alleviate unemployment stemming from socioeconomic crises, including issuing microfinancing, small, and medium-sized loans to affected businesses;
– food security and sustainable food systems (providing physical, social, and economic access to sufficient, safe and nutritious food); 
– improved agricultural practices; 
– reduction of food loss and waste; 
– improved productivity of small-scale producers; and 
– socioeconomic advancement and empowerment (such as equitable access to and control over assets, services, resources, and opportunities; and equitable participation and integration into the market and society, including the reduction of income inequality). 

The latter point, combined with the education options do raise some concerns about the potential of indentured servitude, so much will depend on the way this plays out.

ICMA’s Social Bond Principles nominate the following target populations: 

– those living below the poverty line;
– excluded and/or marginalized populations and/or communities;
– people with disabilities;
– migrants and/or displaced persons;
– the undereducated;
– the underserved (owing to a lack of quality access to essential goods and services);
– the unemployed; 
– women and/or sexual and gender minorities;
– racial minorities; and 
– ageing populations and vulnerable youth. 

A brief history

The first social bond – it was a social impact bond – was launched in 2010 but few issuers came to the market until ICMA launched its social bond principles in 2017.

Danone was the first multinational to issue a social bond in 2018, and a few companies followed suit.

But social bond issuance remained anaemic until covid gave the market a leg-up.

Total issuance of global ICMA-compliant social bonds surged by 720% in 2020 to the equivalent of $149.4bn in 2020, compared with $18.2bn of issuance in 2019.

European and supranational issuers dominate the market followed by Asia, North America, Latin America and the Middle East.  

The Asian Development Bank (ADB) reports that the social bond structure proved popular and well-suited to Asian markets during 2020 and several Asian issuers sampled the market.

The ADB reports that Asian social bond issuance in 2020 has grown 22.3 times since 2017, notes the ADB. 

This compares with 9.8 times for Europe and 14.3 times for the rest of the non-Asian world. 

Global issuance has been dominated by government-related agencies and wealthy countries; but India, the Phillipines, Thailand and a handful of Latin American issuers tapped the market post-covid.

For many years, social bonds severely lagged the green bond market, until covid.

Corporate issuers have to find assets on their balance sheets or eligible projects that meet the issuing principles, which is easier for green projects, given the assets in question are generally easier to ringfence. 

Then in June 2020, ICMA expanded its list of eligible projects and target communities relevant to social bonds in response to the rapid growth of the social bond market due to covid.

Most covid relief bonds are not technically social bonds because they do not adhere to ICMA social bond principles, which among other things require transparency in the form of confirmed utilisation of bonds proceeds for projects with social benefits. 

The matter of principles

Social bond investors share the same investment challenges as do green bond investors.

Lack of standardised metrics can lead to “social” washing, a lack of volume and diversity (more supranational and government agency issuers than corporates and sovereign); and a lack of training among financial advisers to help bring products to market.

As with other ESG finance markets, ICMA has produced a set of principles to guide issuers and investors.

The ICMA 2021 voluntary social bond principles include four core components:

– Bond issuance must be use-of-proceeds bonds;
– Must included a process for project evaluation and selection
– Outline how the proceeds will be management
– Include a reporting process and schedule

To enhance transparency, issuers should employ:

– Social Bond Frameworks; and
– External Reviews

And then there is the overarching rule of ESG investing: “do no harm”.

To date, most issuers also lack a social bond framework, which is considered critical to help investors assess the value of a proposition. 

But frameworks are becoming increasingly evident, a trend that is likely to continue.

Frameworks take time, money and human resources to develop, and professionals with ESG skill-sets are thin on the ground.

Development of a social taxonomy similar to Europe’s green taxonomy, which was recently approved, is also on the drawing board. 

Observers expect the EU will put its mind to a social taxonomy that aligns with its green taxonomy by the end of 2021, given eligible social projects are not yet specified under its “build back better” plan. 

Asian markets have adapted the ICMA principles to suit what they describe as local differences and developed the ASEAN (Association of Southeast Asian Nations) Social Bond Standards. 

Ratings and issuance

In this section, we include covid issuance as part of the total social-bond issuance, given the huge boost to the social market in 2020.

The ADB estimates the weighted average credit rating of the global social bond market is AA, compared with a weighted average of A+ in the global green bond market and AA- in the global sustainability market.

“Broken down by issuer credit rating from international rating agencies, the social bond market almost entirely comprises investment grade (BBB – or better) issues at 99% of total outstanding bonds,” reports the ADB. 

“However, the social bond market shows an even higher concentration of the prime AAA and AA sectors at 79% of the market, compared with 37% for green bonds reflecting higher government agency and supranational bond issuance.” 

Australia’s National Housing Finance and Investment Corporation hit the market in 2020 with a $A562m bond for affordable housing, which meets SDG8.

NHFIC has since issued another $1.5bn, taking total social bond issuance to June to $2bn. 

In the euro market, France’s National Professional Union for Employment and Trade (Unedic) and Cades issued a social bond to support the unemployed and the social security system in France. 

According to Global Capital, Unedic raised E19bn in medium and long-term debt, of which E17bn involved the issuance of social bonds.

The 10-year tranche, which included measurable reporting, was 14x oversubscribed.

Across the Atlantic, US-based Ford Foundation issued a US$1bn social bond in June 2020 – the first by a US non-profit foundation in the taxable corporate bond market. 

It was AAA-rated and 5.8 times oversubscribed.

The bonds, with 30-year and 50-year maturities, carried a fixed-rate coupon of 2.415% and 2.815% respectively.

The funds were earmarked to support and strengthen non-profit organisations hurt by the pandemic.

“The foundation’s primary goal will be to stabilise and strengthen key organisations that are advancing the fight against inequality when communities that are most vulnerable have been hit hardest by the pandemic,” said the foundation in a press release.

Charities present their own peculiar risks

“The road to hell is paved with good intentions.” – Henry G. Bohn, 1855.

Charities of the size and repute of the Ford Foundation are considered excellent credit risks.

However, the Ford Foundation’s has a chequered past, most notably with its association with the Pinochet dictatorship in Chile which “disappeared” at least 1,248 people and tortured another 9,800 political prisoners.

While the foundation did eventually depart from Pinochet’s Chile, it is a prime example of the many charities that include in their portfolio less-than-altruistic activities.

The Rockefeller Foundation, for example, one of the main supporters of ESG, was also involved in Chile.

Even recently, India’s Modi government cracked down on more than 13,000 NGOs, of which Ford Foundation was one, wary of foreign meddling in internal affairs.  

Times Now reported that the Gujarat police had asked the Ministry of Home Affairs to look into whether the Ford Foundation had violated rules governing foreign donors and whether the foundation had acted in conflict with “India’s national interest”. 

The Ford Foundation was placed on Prime Minister Nahendra Modi’s watch list.

The point here is that many NGOs have well-established records of involvement in the affairs of the countries in which they the operate, part of which occurs naturally through the charity interface. 

But these boundaries are often blurred and sometimes deliberately transgressed, creating risks for ESG investors, which we discuss later.

A Philanthropy News Digest review of Foundations of the American Century: The Ford, Carnegie, and Rockefeller Foundations in the Rise of American Power includes the following quote about the book’s central thesis:

“Far from being independent “third sector” institutions committed to solving problems of human suffering, the “Big Three” (Carnegie, Ford and Rockefeller) foundations have instead acted as champions of pro-American free-market capitalism and opponents of “nationalistic/leftist philosophies and alliances”.

Geopolitics of social bonds

When viewed through the lens of geopolitics, social bonds present a different game.

Social bonds could harness masses of “non-aware” capital to fund international policy agendas and policies that may undermine the very goals some investors are attempting to reach. 

It opens serious questions about the ability of social bonds to be used in geopolitical cold warfare.

Social bonds can easily end up serving the charitable foundations of those countries with the deepest pockets – whether it be China, the US, Europe, etc. 

The big three foundations are not the only charities that have received scrutiny. 

Many extremely respected health charities around the world have been found to be at the behest of pharmaceutical companies, experiencing a conflict of interest when it comes to developing cheap universal cures as opposed to expensive, often recurring, treatment of symptoms.

It is a similar situation for many other sector and industry-related charities.

While the proceeds are earmarked for certain projects, the receipt of ”social” funds would still free up a charity’s other funds to deploy to its own agendas.

And it is not a situation that is likely to change. As Philanthropy News Digest continues:

“In short, Parmar sees little reason to believe that American foundations can or will change. 

“While foundation trustees are now more representative of the general population, and while new institutions such as the Bill and Melinda Gates Foundation have begun to overshadow the Big Three, Parmar believes that US foundations are “hard-wired” to support the status quo by virtue of the interconnected nature of government, business, academia and private philanthropy in the US.”

Know thy charity

We use Ford example, because it highlights a risk for ESG for social funds that support charitable “agendas”.

Such concerns are unlikely to bother socially neutral investors (those whose motive for investing in social bonds is purely financial), or those who believe the goals of American/Chinese/Russian/European hegemony (depending on the issuer) might be in global interest; but not all investors will feel the same way.

In theory, it also demonstrates the democratic nature of social bonds in that investors can choose to invest in a range of charities of their choice, even if that includes those that offer defacto geopolitical interference.

In reality, the concentration of funds in the hands of a few people or nations have the potential to undermine democracy.

And there is also the ESG investing principle of "do no harm" to consider.

Most passive investors will be leaving the nitty gritty of those decisions to fund managers.

One would assume the big three foundations would represent an excellent credit risk in nearly all circumstances, but there is always the ball from left field.

Lesser charities could represent greater risks and prove problematic for ESG fund managers, should they find themselves at the centre of a scandal that conflicts with their investment guidelines.

These funds might be forced to sell positions, which could have a systemic impact.

Or a sovereign nation may punish a fund.

Genuinely concerned social investors may need to dig deeper to ensure issuance matches their priorities. 

In the spirit of the ESG investment catchcry “Who Cares Wins”, it is a reminder that the easy days of investing may have had their day. 

Teasing out the web of control structures and activities within the private and charity sectors is a diabolical task, and as they say, the road to hell is paved with good intentions.

Much will depend on the original intentions of the architects of ESG and those driving its implementation.

As always, it is buyer beware; and the best advice to investors is to know thy charity.

Emerging and developed markets in Asia

The above issues gain even greater significance viewed through the SDG lens of aiding developed economies.

Do the UN’s Sustainable Development Goals represent aid, financial exploitation, a vehicle to promote western hegemony, or all three?

If so, they represent a gnostic-worthy universal entanglement of good and bad.

While the SDGs apply globally, much of the emerging markets focus is likely to be on the highly populous and semi-industrialised nations of Asia.

ESG finance will definitely allow investors to build a stake in the future growth of nations, which is not necessarily a bad thing depending on whether investment is of benign or sinister intent. 

For example, the International Finance Facility for Education, launched in 2020 in support of SDG goal 4 (education), aims to galvanise at least $10bn in bonds for education finance issued by multilateral development banks, appears on face value to be relatively benign, ring-fencing education spending in lower-middle-income countries. 

“Through grants and guarantees of principal, these efforts are expected to lower borrowing costs and risks, providing benefits for issuers and investors alike,” says Brookings. 

Meanwhile, the Asian Development Bank reports that Australia has the highest outstanding social bond issuance in Asia thanks largely to the National Australia Bank ((NAB)) and the Australian government.

China follows, mainly through the Bank of China and the Beijing Infrastructure Investment Co; then India’s corporate and transport issuers, Japan’s corporate and government related issuers, Philippines corporate issuers then Korea’s corporations and government.

Asia was slow to issue social bonds until it developed the ASEAN Social Bond Standards, that specified all issuance must have a geographic or economic connection to ASEAN countries.

Meanwhile, harking back to the use of social bonds for crisis capitalism in our previous article, the SURE  (support to mitigate unemployment rate in an emergency) Programme should reach a total of E100bn.

The African Development Bank also launched a US$3bn “Fight covid-19” social bond, becoming the world’s largest dollar-denominated social bond transaction to date.

Sustainability bonds

Sustainability bonds are use-of-proceeds debt instruments for which the proceeds are exclusively applied to financing or refinancing a combination of both green and social projects or general sustainability themes.

They are designed for issuers that are mainly or entirely involved in sustainable activities, but whose bonds may not align to the four core components of the social or green bond principles.

Many issuers have been exhibiting a preference for sustainability bonds over social bonds and increasingly are issuing social bonds, and green bonds for that matter, through sustainability bond frameworks.

These are not to be confused with their “floating-rate” brothers – sustainability-linked bonds, which we discuss in future articles.

Market trends over the past five years have suggested that many issuers prefer the flexibility of sustainability bonds to social bonds. 

The value of sustainability-bonds issuance is also gaining ground on the more established green bonds.

The Climate Bonds Initiative reports that in 2020, the total size of the sustainability bond market hit US$316.8bn, inching out the social bond market at US$315.6bn (which had been buoyed by covid-related issuance).

Demonstrating faith in the market, many countries are now jostling for pole position as a trading centre and offer exchanges for sustainability bonds.

Sustainability bond exchanges are offered by Stockholm, Nasdaq, the International Stock Exchange, Nigerian Stock Exchange, and the Toronto Stock Exchange and more.

ICMA has developed Sustainability Bond Principles, which mimic the social bond principles listed above.

ICMA encourages issuers to establish Sustainability Bond Frameworks and to adopt, where possible, the relevant best practice of the green and social bond principles.

In our next series, we shift our focus to sustainability-linked finance.

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