Social bond issuance soars as COVID-19 recoveries begin

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White & Case LLPGrowing investor appetite for financial products with a positive impact, coupled with a demand for recovery capital post-COVID-19, have lifted the market for social bonds.

Investor interest in social bonds—securities raised to fund specific social projects—has soared during the COVID-19 pandemic.

For example, according to Morgan Stanley, the US$48.5 billion of bonds raised for ESG purposes in April 2020 was more than double the amount raised in March and represented a 272% increase on volume recorded in April 2019.

Funding our future

This growth has been predominantly due to the impact of COVID-19, which has financial markets turning to sources of capital that can fund the recovery while simultaneously delivering social benefits.

AXA Investment Managers expects that healthcare systems, governments and businesses will require “hundreds of billions of dollars” to navigate the exit from COVID-19 and recover from the impact of lockdowns. The International Monetary Fund forecasts that the pandemic will cost the world economy at least US$9 trillion. Social bond funding could play a key role in helping communities recover.

The market has already seen the first wave of “COVID-19 bond” issuance by a range of borrowers. Pharmaceutical multinational Pfizer, for example, raised a US$1.25 billion sustainability bond to fund healthcare systems and extend access to its drugs and any vaccines, and others are following a similar path.

Setting parameters

The term “social bond” currently has no legal definition. Unlike green bonds, which have tightly worded criteria, there is considerably less clarity on what constitutes a social bond.

For example, ING, which tracks sustainability bond issuance in Europe, distinguishes between the €237 billion of “pandemic bonds” issued in H1 2020 and sustainability bond issuance of €135 billion during the same period. According to the bank, the “pandemic label” only requires a term sheet reference to using proceeds to fight COVID-19, with no underlying framework to monitor compliance. ING says only around 15% of pandemic bonds have a social or sustainable framework.

The Financial Times, meanwhile, reported that some issuers provide only vague criteria for the use of funds. With no fixed market standards in place, it can be difficult to hold borrowers accountable if they use proceeds outside of specific projects and initiatives.

Tightening and standardizing the definition of a social bond is essential if the asset class is to reach its potential and develop into more than a marketing wrapper for what would otherwise be standard debt issuance.

Rules and regulations

Although there is still work to do, initiatives are underway to establish a clear set of social bond criteria. The International Capital Market Association (ICMA), for example, published its first set of social bond principles in 2017 and has updated them, most recently in June 2020.

The social bond principles are voluntary guidelines designed to promote integrity in the social bond market. The latest updates are intended to further improve the transparency, reporting and disclosure of social bond performance and outcomes.

Similar to the green bond guidelines, which are seen as the market standard, the ICMA’s social bond principles specify that any bond that claims to be a social bond should: (i) specify use of proceeds; (ii) outline a process for evaluation and selection; (iii) manage proceeds accordingly; and, (iv) report on compliance. The updated social bond principles also define what constitutes a “social issue” and offer expanded examples of “project categories” and “target populations.”

The ICMA believes that establishing the market’s credibility will support investor confidence and see greater allocations made to social bonds.

Investment managers have also adopted their own processes for assessing social bond credibility. AXA Investment Managers, for example, considers the overall environmental, social, and governance (ESG) status of each issuer before conducting detailed analysis of the project for which the borrower is raising a social bond, how the money will be managed and what reporting will be put in place.

A positive outlook

The greater attention managers are paying to in-house social bond investment criteria is part of a wider institutional investor shift, backing assets and investments that not only deliver financial returns, but also produce positive environmental and social impacts.

Investors with a strong sense of moral purpose and a desire to invest accordingly may be significant drivers in the coming years. Morgan Stanley estimates that some US$30 trillion will change hands during the decades to come, passing from the baby boomer generation to social and environmentally conscious millennials.

This will drive increased demand for financial products like social bonds. Pension funds and institutions have already been adapting to this new reality. The number of institutions signed up to the UN’s Principles for Responsible Investment (PRI), for example, has more than doubled during the last decade, to around 2,400. PRI signatories now control some US$86 trillion of capital between them and the numbers continue to grow. In its most recent annual report, the PRI reported more than a 20% increase in the number of signatories over the 2018/2019 financial year, the greatest growth in the PRI signatory base since 2010/2011.

If the market can continue building a credible social bonds taxonomy, the potential for the long-term development of social bonds as a mainstream asset class, rather than a short-term response to COVID-19, is immense.

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DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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