Designing the next generation of SRI deals

The increasing breadth and depth of the SRI investor base has provided new opportunities for individual issuers to fund in the capital markets, but its growth is also sparking innovative instruments with the potential to harness private sector capital for huge social gains. Steve Gilmore reports.

  • By Gerald Hayes
  • 30 Sep 2013
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Socially responsible investing has come a long way from religious institutions and universities trying to avoid investing in the arms industry or cigarette companies. What began as an attempt among a narrow group of investors to screen their portfolios against a narrow group of unsavoury assets has since become a voracious pursuit among institutional and retail investors around the world for the most effective ways to use investment capital for social good. 

Increasingly this means issuers in SRI markets no longer need supranational or government agency issuers to pass on capital market funding through themed bonds. Environmentally conscious investors now have a wide selection of instruments to choose from. Green bonds issued by the big public sector borrowers such as the World Bank and the European Investment Bank paved the way, becoming a popular mainstream fixed income product. But the project finance market now provides renewable energy ventures direct access to capital market funding, and in a way that transfers construction risk to the investors.

“Green bonds entail a label applied to a broad range of instruments, but the innovation in this case has been to structure a deal that can fund a project that doesn’t as yet exist,” said Nasser Malik, head of global structured debt at Citi. “Although these solar or wind projects have contracts in place regarding procurement of inputs — who will run the project and who will buy the power — the investors take the risk around the construction.”

In other cases the rise of socially responsible investing has allowed issuers to attract private capital without relying on relative value. The Nature Conservancy, a Washington-based non-profit organisation that aims to protect ecologically important areas around the world, has issued Aa2 rated corporate debt since 2008. But it has recently branched out to offer retail investors with what it called a “conservation note” in one, three and five year maturities, and at fixed interest rates set by the company not the market. 

Testing the waters

When the organisation first issued its conservation note the rates it set were close to market rates, which helped ease investors into the new product. The one year note yielded 0.75%, the three year 1.25% and a five year note 2%.

“We didn’t really test the proposition that buyers would be willing to take below market rates, but we told investors that although our yields were close to those for double-A rated corporate debt, if rates rise in the future Nature Conservancy won’t chase the market,” says Charlotte Kaiser, the company’s director of innovative finance. 

The early indicators are positive. Nature Conservancy has already redeemed some of its one year bonds and almost all noteholders reinvested. Other non-profits’ experience with similar instruments gives no reason to think demand will tail off as market and conservation note yields diverge.

Institutional buyers, even those committed to social outcomes, are not about to set aside their total return mandates any time soon. But changing attitudes across retail and institutional groups has helped spur the development of new ways of capturing private sector capital to fund development goals. 

More and more bond investors have an investment strategy that includes a focus on specific SRI areas. The bond markets are playing catch-up in this respect with the equity markets, where there have been pension funds focused on ethical investing for some considerable time. But the exponential growth in the fixed income arena suggests that the gap is shrinking significantly, says Vince Purton, head of debt capital markets at Daiwa Capital Markets in London.

Not only is the gap shrinking but innovative new debt instruments are being built. Increasingly, chief investment officers want products that have a component concerning issues that his or her stakeholders are interested in, and this is what lays the ground for social and development impact bonds, says Robert Annibale, head of microfinance and community development at Citi, and member of a Development Impact Bond working group convened by Washington-based think tank the Center for Global Development and UK non-profit Social Finance UK.

Proof of impact 

Six social impact bonds (SIB) are in operation worldwide though many more are being designed, and several development impact bonds (DIB) are in the planning stages. Neither instrument meets the traditional capital markets definition of what a bond is. They are not tradable. They are not rated. They do not pay regular coupons. But they do offer the potential of a new asset class that could direct private sector capital and expertise towards social and development goals.

Social impact bonds are essentially a contract where private investors provide upfront capital to pay for an intervention or programme aimed at providing better outcomes. The government chooses the area of intervention, which to date has included lower rates of recidivism in the UK and Australia, unemployment in communities in Israel and homelessness in the US. If the defined aims are met then the government repays the investors.

Tackling recidivism

In the UK’s first SIB — launched in 2010 — investors funded attempts to reduce recidivism among prisoners leaving Peterborough jail. If re-offending drops by 7.5% or more over six years the UK government will pay investors a share of its long term savings, and if re-offending drops further investors could receive a return on their original investment of up to 13%. 

Development impact bonds have adapted the SIB concept to problems in developing countries. Investors could fund development programmes, which if successful, would result in donors or developing country governments providing remuneration.

“As you move into social impact bonds and other asset classes being considered the innovation is around what the alternative source of revenue is going to be when the activity you are trying to fund doesn’t create revenue itself,” says Audrey Choi, head of global sustainable finance at Morgan Stanley in New York.

Development and public sector professionals have been the main drivers behind both instruments, but investment banks have already helped push SIBs in the US and Australia. Goldman Sachs is a partner in a New York City SIB aimed at reducing recidivism, and funded it with a $10m investment. Westpac funded the junior tranche of a A$10m SIB aimed at reducing family breakdowns and the number of children in foster care in New South Wales.

In the short term, SIB and DIB investors are still likely to be charitable donors and private philanthropists. But Michael Belinsky, a founding partner at non-profit Instiglio, which creates social impact bonds, says there are roles for institutional investors and investment banks to play in social impact and development impact bonds.

“These instruments will create new opportunities for institutional investors,” he says. “Although we’ve yet to see at what rate of return those investors will be able to participate, the potential rate of return we’ve seen for social impact bonds is around 7%-13% and we expect that to continue in future pilot programmes.”

An attractive rate of return is not the only attribute they could offer a socially minded investor. They are unlikely to be highly correlated with other fixed income asset classes and would offer investors exposure to developing countries with far better growth prospects than most of the developed world.

Data revolution

As with social impact bonds, investment banks could be among the potential investors in DIBs. But their close relationship with institutional and retail buyers also puts them in a strong position to intermediate. Social and development impact bonds are likely to be small by capital market standards. Unrated and untradeable they will require a lot of effort to get buyers involved, despite the rate of returns on offer. However, investment banks’ comparative advantage in risk assessment and analysis could be used to generate a critical mass of potential investors.

“I’d like to see investment banks thinking of ways to get together groups of investors who would individually be unwilling or unable to do the necessary due diligence, and working to assess risks on their behalf to enable pools of investors to participate,” says Owen Barder, a senior fellow and director for Europe at The Center for Global Development.

This will take a great deal of time and effort. But the potential benefits are enormous, and for investment banks and investors these instruments will offer the closest thing to proof of impact that either group is likely to get from their investments.

“If you are paying private sector investors you need to have measurements of progress that you and they agree on, and that aren’t subject to gaming, corruption or luck,” says Barder. “The data revolution is the basis on which these new instruments depend — you can’t have a private sector contract if you can’t adequately measure the outcomes.”

The transparent structure of SIBs and DIBs, the clear outline of their goals and the rigorous analysis of their results are exactly what institutional investors want when approaching SRI products, and not something on offer elsewhere in the SRI market.

“As an investor you want as much disclosure as possible, a good understanding of how the proceeds are being used and some measure of the impact of the investment,” says Stephen Liberatore, a fund manager at TIAA-CREF in New York. “Good disclosure and the demonstration of direct positive impact are fundamental to evaluating socially responsible investments.”

Secondly, because of the areas these instruments will target they have the potential to yield colossal social and economic returns — clean drinking water, HIV prevention and secondary education are just some of problems DIBs are being designed to target in developing countries. 

But they also provide a new way for individuals across development, finance and government to bring their individual expertise to bear on issues of critical importance. The government will still pick the areas it deems most important, development professionals will still offer expertise and advice, but there is now the potential for mainstream capital market investors to help fund targeted interventions.

“If you look at our working group on DIBs what’s interesting is that you’re bringing together development professionals, government officials and private sector institutions like investment banks,” says Annibale. “The reality is that these development problems are complex and it requires a wide range of expertise to construct instruments suitable to tackling them.”

  • By Gerald Hayes
  • 30 Sep 2013

All International Bonds

Rank Lead Manager Amount $m No of issues Share %
  • Last updated
  • Today
1 JPMorgan 317,793.98 1355 8.72%
2 Citi 301,114.13 1092 8.26%
3 Barclays 259,580.63 846 7.12%
4 Bank of America Merrill Lynch 258,842.43 934 7.10%
5 HSBC 224,273.23 905 6.15%

Bookrunners of All Syndicated Loans EMEA

Rank Lead Manager Amount $m No of issues Share %
  • Last updated
  • 18 Oct 2016
1 JPMorgan 29,669.98 55 6.95%
2 UniCredit 28,692.62 136 6.73%
3 BNP Paribas 28,431.90 139 6.66%
4 HSBC 22,935.49 112 5.38%
5 ING 18,645.88 118 4.37%

Bookrunners of all EMEA ECM Issuance

Rank Lead Manager Amount $m No of issues Share %
  • Last updated
  • 18 Oct 2016
1 JPMorgan 14,593.71 79 10.38%
2 Goldman Sachs 11,713.19 63 8.33%
3 Morgan Stanley 9,435.23 48 6.71%
4 Bank of America Merrill Lynch 9,019.27 40 6.41%
5 UBS 8,763.73 42 6.23%