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Beyond green: public sector pioneers explore new SRI ideas

By Craig McGlashan
01 Apr 2015

Bonds with an environmental, social or governance theme became very much a mainstream product for public sector borrowers in 2014. From that stable base, the market is ready to expand its reach into more diverse projects and currencies this year as fresh issuers come on board. Craig McGlashan reports.

The growth of environmental, social and governance bonds (ESG) is overwhelmingly driven by paper linked to environmental projects. But as ESG becomes more of a main topic of discussion for investors, issuers are finding that they can add a socially responsible flavour to their bond offerings in other ways.

In January, Instituto de Crédito Oficial sold a €1bn December 2017 social bond aimed at generating economic growth in Spain.

“We could have done a green bond, but it makes more sense for an organisation like Ico to do a social bond because it is focused on contribution to growth and employment,” says Rodrigo Robledo, head of capital markets at Ico in Madrid.

The success of the deal — it drew a book of over €2bn that included first time buyers of Ico as well as some investors that had not bought the name in years — did not go unnoticed by Ico’s peers, says Robledo.

“I know some other agencies are working on similar ideas,” he adds.

Almost all of the SSA market participants spoken to welcomed the introduction of social bonds, but many doubt whether they will be able to grow in volume to the same extent as their green counterparts.

“There are investors that want to buy bonds with more of a social theme,” says Greg Arkus, head of SSA DCM at Credit Suisse in London. “There’s a market there, but the challenge is that it crosses over with microfinance initiatives. You’ll continue to have social impact bonds, I’m just not convinced it will become a big market given that projects being funded will remain targeted and small in comparison to general funding needs.”

Issuers that are considering a social impact bond could find a large crossover with the green bond audience.

“Investors which have an SRI focus may be willing to consider both green and social and then it depends how they are set up,” says Martin Mills, head of green DCM, EMEA at Bank of America Merrill Lynch. “Some have established distinct green bond funds, so social bonds by definition will not fit. But they may well fit into another fund depending on the mandates that the investor holds.”

Others suggest that deeming a project to have a social impact is more subjective than one aimed at tackling climate change.

“What’s called ‘social’ in Mississippi is going to be very different to what’s called ‘social’ in Germany,” says Sean Kidney, chief executive of the Climate Bonds Initiative in London. “So it’s going to be bespoke and bespoke markets don’t scale. I’d like it to be a big standardised market but it’s challenging in the social area.”

Standing out

Ico had to come up with its own way to mark out bonds having a social impact. Proceeds from the deal will be used to lend to SMEs based in Spanish regions with GDP per capita below the Spanish average, and industries not deemed socially responsible, like alcohol or tobacco, are excluded.

“We need to justify that we have some impact in terms of growth,” says Ico’s Robledo. “It’s very difficult to measure SME by SME, because we’re talking about thousands of micro SMEs we are working with.

“We have decided to focus on those regions in Spain with a GDP per capita below national average, because we believe it is important to put an emphasis on job creation at the moment. We had discussions with SRI analysts during the roadshow, and they were pleased with the approach we have decided to follow. Right now, our goal is to put our efforts to make improvements in this type of issuance, and enhance the procedures to measure its impact.”

Maria Parada-Rajmankina, vice president, DCM at RBC Capital Markets in London, agrees with Kidney in saying that for the social bond model to grow, it needs to enjoy the same levels of standardisation as the green product. 

“The environmental theme will likely continue to dominate the market, and one factor behind that is there has been issuance from various SSAs for a number of years, so there’s more standardisation,” she said, “while other themes are newer and might need a bit more standardisation in terms of the criteria used,” she says.

For green bond standardisation, market participants have created a set of voluntary principles that focus on four components: use of proceeds, process for project evaluation and selection, management of proceeds and reporting.

As the principles do not describe what qualifies as “green”, they could easily be used by social bond issuers too — and Ico did just that with its deal. Others could follow suit, says the CBI’s Kidney.

“It’s important to note that the green bond principles don’t try to tackle the definition of ‘green’,” he says. “That’s why we’re doing our work in the area as a complement. They tackle the reporting aspects, which absolutely should be applied to social bonds as well, and are being applied. So you could easily call it the green and social bond principles without any trouble.”

Green shoots

While new forms of SRI bonds are arriving from SSA borrowers, the bulk of this year’s volume is expected to stay on the environmental side. But there is a differing of opinion over how much the market will grow.

“You may see some growth in socially themed bonds but the environmentally themed bonds will continue to be the bulk of the growth,” says Paul Belanger, managing director, government finance DCM at RBC Capital Markets in Toronto.

“Some people have projected $100bn in green bond issuance this year which may be optimistic, but at the same time the rate of growth over the last couple of years has been quite aggressive.”

Others, such as CBI, estimate that overall green bond issuance will hit $100bn this year, up from $36.59bn in 2014 — and expect SSAs to be the key part of that growth.

“There’s been a few sub-sovereigns out of Scandinavia already, but we’ll see quite a lot more this year,” says CBI’s Kidney. “Every development bank and their dog is going to have a shot at this. 

“Growth in volume will be as strong this year as last, and two areas I’m most optimistic about are SSAs and municipalities.”

With many SSAs already established as green bond players, some may look to augment their issuance with expansion into other currencies.

“While dollars and euros will continue to dominate issuance, we do expect to see a bit more growth in other markets, like Australian and Canadian dollars, where the market has really started only last year,” says RBC Capital Markets’ Parada-Rajmankina. “It’s difficult to put a number on how much issuance there will be but we will definitely see more.”

But some growth could even come from the one letter in the SSA acronym that so far has been missing from green bond issuance: sovereigns.

“It’s only a matter of time,” says CBI’s Kidney. “What I can’t tell is whether the first will come from high risk sovereigns trying to get attention in international markets for their bonds, or it’s going to come from blue chip sovereigns trying to make a political statement. 

“You won’t find a treasurer in a developed market that thinks this is a good idea. No treasury official likes to hypothecate funds. But from a political perspective, for some governments this is an attractive prospect for a variety of reasons. And there is the argument of providing liquidity to markets, as liquidity tends to come from sovereigns. The development banks have taken that role. But it would get a great fillip, especially in different currencies, to get sovereign issuance.”

That sovereigns are about to join the green bond party is far from a universal view, however.

“I haven’t seen much interest from pure sovereigns to do a green bond,” says Jigme Shingsar, managing director, DCM at RBC Capital Markets, New York. “It’s not to say that can’t change. But the vanguard has been the agencies and the supranationals. I’d be surprised if we saw one this year.”

Smarter players

As more and more issuers enter the green bond market and those that are already present augment their approaches, investors becoming ever savvier.

Some are creating dedicated green bond portfolios, while discussions around SRI subjects are becoming a mainstay of roadshows. But the increasing sophistication of investors does not mean that second opinion providers like oekom or Sustainalytics will become unnecessary, say bankers.

“More investors are getting in-house capacity to analyse the ESG component of the bond, so we see a greater degree of expertise emerging,” says BAML’s Mills. 

“Does that mean the second opinion providers will become redundant? No, because in Europe at least there’s a culture that opinions are sought and provided. Each individual provider has a different type of approach and we don’t see that those will necessarily converge as they have different areas of focus.”

Indeed, such providers have an important part to play to make sure that the green bond asset class keeps doing what it says on the tin.

“People always talk about the biggest threat to the market being reputation — making sure you do what you say, distribute the assets like you’ve said, realise the impacts you’ve forecast etc,” says Raymond Seager, head of SSA DCM at BAML in London. “But nobody’s really suggested that hasn’t happened or we’ve even come close to that being the case.” 

By Craig McGlashan
01 Apr 2015