So far green bonds have dominated the still young ESG capital markets. But in the last 12 months a pair of issuers have brought bonds based on social themes in benchmark size. Tessa Wilkie reports on how we are about to see a lot more of them.
Social bonds are ready for lift-off after several issuers debuted such deals in the past 12 months.
The sector encompasses a wide variety of bonds that finance projects designed to benefit society — such as boosting education, employment or providing healthcare. Some, such as a social impact bond from New York State designed to reduce re-offending by ex-prisoners, have extra pay-outs tied to the success of the projects they are funding.
One potentially large area for growth is local authorities — they could print social bonds to fund social housing, for example.
“Social housing could be a big growth area if local councils embrace themed bond issuance,”says Nick Dent, head of syndicate, EMEA, at Nomura in London. “Instituto de Crédito Oficial raised €1bn through a social bond — that just shows the scale that can be achieved in this market. Some regions are more adept and familiar with accessing the capital markets than others. The private sector will be a part of this too but scale will come from the regions and local governments.”
Lee Cumbes, head of SSAR DCM at Barclays in London, agrees: “Social housing is where I see sizeable potential for immediate growth and benefits. Looking at where banks lend money, there’s much volume [going] to business and housing. The potential for private sector bonds financing social housing is significant, should that be desired by investors.”
The daddy: IFFIm
The social bond was one of the first to emerge from the ESG sector on to the capital markets scene. The International Finance Facility for Immunisation was the first issuer to print a benchmark-sized themed bond, a $1bn print in November 2006.
This was before the European Investment Bank and World Bank — two pioneers of the green bond market — first placed bonds where the use of proceeds were ringfenced for tackling climate change. However, while the green bond market took off after the EIB and World Bank blazed the trail, the social sector was much more intermittent and, aside from IFFIm which continued to issue benchmarks, was dominated by private placements or Uridashi notes. But that has changed over the last 12-18 months, with a cluster of issuers entering the benchmark arena with bonds backing social themed projects.
Inter-American Development Bank sold a $500m four year education, youth and employment (EYE) bond via Citi and Daiwa in September 2014, while Spain’s Instituto de Crédito Oficial followed that with an even bigger effort in euros: a €1bn 0.5% December 2017 bond whose proceeds were earmarked for Spanish SMEs based in regions with a GDP per capita below the national average. SMEs in industries not considered socially responsible, such as alcohol and tobacco, were excluded.
Further north, the German state of North-Rhine Westphalia sold a debut €750m 0.5% March 2025 sustainability bond in March this year. About half the proceeds were allocated to green projects, while the other half went to education and social projects. Eligible projects included those related to education, sustainability research, inclusion and social coherence.
NRW hopes to print another €1bn when it returns to the format in the first quarter of 2016.
The majority of debuts has come from supranationals, regions or agencies, but the private sector has got involved too: Lloyds printed its second ESG bond — a £250m seven year — in May. It debuted with a £250m four year senior unsecured deal in July 2014.
If the buyer is willing
The last 18 months have proven that there are plenty of investors keen to get their wallets out when a social bond is on the table. Lloyds, when it began thinking about ESG issuance, considered printing a bond that focused on climate change projects, but found that investors were open to broader themes.
“When we evaluated a green bond we began to realise that a lot of investors were focussed on ESG as a broader concept so we began to look more at the ESG aspects of our loans rather than focusing on green,” says Adam MacDonald, director, capital markets at Lloyds Bank Commercial Banking in London. “We launched our Helping Britain Prosper Plan in March 2014 where Lloyds made very strong social commitments so we felt that our bond should reflect our bigger presence in the social component of ‘ESG’.
“We focussed the first two transactions on our SME businesses where we are committing to grow net lending by £1bn per annum.”
The bank’s debut was a resounding success with the ESG investor base. About 64% of the deal was placed with what Lloyds called tier one ESG investors — dedicated socially responsible investment or green funds and investors with a strong commitment to ESG. Tier two investors took 21% — these are investors that are defined as signatories of the United Nations’ Principles for Responsible Investment that have evidence of moving towards ESG integration in their investment strategies.
“We have found a number of new investors came into our ESG bonds, mainly ethical/sustainable and responsible capital markets funds that are very supportive of this form of note,” says Macdonald. “Some investors that were already supporters of the Lloyds name took larger tickets than for ‘vanilla’ issuance due to an increase in the number of their ESG mandates.”
Spain’s Ico also feels that social bonds are a better fit with its business model.
“We did look at the possibility of selling a green bond, but since our core activity is SME lending (it stands for about 60% of our portfolio),” says Rodrigo Robledo, head of capital markets at Ico in Madrid, “we felt it was a much more natural fit for us to launch a social bond, which has an impact on boosting employment and creating economic growth.”
Both IADB and Ico found that investor diversification was a benefit of printing a themed bond. Ico’s €1bn deal was more than twice subscribed. ESG investors made up about 35% of the distribution.
“We had many investors participating in our debut EYE bond which either hadn’t bought our bonds before or hadn’t for many years,” says Laura Fan, head of funding at the IADB in Washington DC. “That was an extremely positive result.”
IADB’s debut EYE bond attracted over $600m of orders and more investors have since expressed interest in buying the line.
“We are not planning to issue another EYE bond in benchmark size this year,” says Fan. “We plan to issue EYE bonds customised to meet the specific needs of the investor. For example, we have sold three EYE bonds based on reverse inquiry — a $5m five year callable step-up note sold to a US investor; a $50m three year fixed rate note targeted to a US investor; and a Mp800m five year fixed rate note bought by Dai-Ichi Life Insurance. These customised deals allow us to issue EYE bonds which suit the investor’s timing and currency requirements.”
Japanese institutional investors are increasingly interested in social bonds, says Carlos Perezgrovas, executive director, DCM at Daiwa Capital Markets in London. “For years we have seen strong appetites for social bonds in the Uridashi market but we’re beginning to see a considerable increase in demand from Japanese institutional investors too. This interest is likely to continue and as a result we expect to see more public and private placement social bonds out of this region.”
Too big to handle?
However, one of the sector’s main impediments is the sheer breadth of projects that can be considered social. While climate change projects are somewhat limited, by definition, the number of different types of projects that can be deemed to have social benefits is vast, making standardisation, and therefore scale, difficult.
The social bond sector can grow much larger than it is already, but its diversity means it will probably not grow as big as the green bond market, says Christopher Flensborg, head of sustainable products at SEB in Stockholm.
“Some investors have other priorities beyond climate change and many would be happy to buy bonds backing projects to improve health, education and employment,” he says. “But where the funds are going needs to be illustrated clearly and that is harder when you are looking at such a broad sector as social bonds. The goals of social projects are not as straight-forward or as tangible as climate projects, so it’s more difficult to harmonise.”
For example, only International Finance Corporation has printed what it calls Inclusive Business Bonds — bonds where proceeds go to projects involving people earning less than the equivalent of $8 a day — and Banking on Women Bonds that go towards projects supporting small and medium-sized businesses owned by women in developing countries. The European Bank for Reconstruction and Development has sold microfinance bonds, and Rabobank has printed agriculture bonds, which support sustainable agribusiness in developing countries.
The social bond market will have to go through the same growing pains that green bonds did — discussing what constitutes social bonds, how they should be reported and how standards should be upheld.
However, because of the diversity of social loans, it is difficult to find a way to standardise reporting.
“Social impact reporting isn’t as straightforward as if you had a wind farm and can calculate the energy output of that wind farm and so measure the carbon emissions reduction,” says Lloyds’ Macdonald. “Our bonds are allocated to well over 1,500 loans so it’s not practical to ascertain the full impact of every one.
“The impact reporting we provide is partly at a portfolio level, for example amounts loaned to SMEs and healthcare providers in deprived areas or how much we lend to various renewable energy technologies.
“In the case of certain loans we have disclosed the number of jobs that have been directly created or saved by the lending. We also provide case studies on a number of individual loans.”
Ico is facing reporting on an even larger number of loans than Lloyds — that means it cannot provide the same level of detail on its projects as a green bond issuer might.
“Some green investors were very demanding on the reporting, and we completely understand the importance of being accurate on this aspect, and the need for issuers to commit to this matter,” says Ico’s Robledo. “Nevertheless, one important thing investors should bear in mind is that, when it comes to green bond reporting, the issuer can easily provide detailed information about each and every project. Yet, with social bonds, it is quite a bit more difficult: with the €1bn trade, we are funding around 20,000 loans with an average size of €50,000 each, so it is more complicated for us to obtain case-by-case impact studies.
“With our social bond, in order to maximise the social impact of the proceeds, we focused on SME lending to regions in Spain with less growth and unemployment higher than the national average. Thus, we need to provide a more general reporting so as to display the economic impact of the lending. Even so, we are very happy to say that most investors were pleased with the criteria we selected for our bond and that 35% of the bond was bought by ESG investors.”
Adds Dent: “Reporting for social bonds could involve a little more work than for green bonds. How do you report the impact of a social bond that is intended to stimulate job creation? It’s tough to define. Can you show that you are creating the right kind of jobs?”
For sophisticated public sector issuers or banks that already have systems in place the additional investment in reporting infrastructure to print a themed bond is bound to be less onerous than for some regions, banks or corporations with less developed internal infrastructure that might want to look into selling social bonds.
“It’s a lot of work internally for the issuer — do they need verification and monitoring?” says Vince Purton, head of DCM at Daiwa Capital Markets in London. “It can require big internal investments before it’s possible to provide reporting of the level and detail that investors require. But there is room to fragment away from a market that is rigidly green. Deals like the IADB’s EYE bond show there is room for that.”
Given the extra commitment in time and resources that printing a socially themed bond requires, many issuers might be understandably reluctant to jump into preparations to print unless they know they are definitely going to get something out of it.
So far, issuers say there is no pricing advantage in printing a social bond. But, as with green bonds, many market participants believe that as demand for themed bonds grows, then a pricing advantage could be had.
“For us at this stage, the main advantage of selling an ESG bond is for investor diversification,” says Ico’s Robledo. “But we expect there to be a pricing advantage in future when the market is more mature.”
A principled approach
Some guidance in the form of industry-led principles could help. Three banks have proposed a Social Bonds and Sustainability Bonds Appendix to the Green Bond Principles in the hope of giving the social and sustainability bond market more clarity and confidence. The Green Bond Principles, first published in 2014, helped to add clarity to and promote standards in the green bond market. Crédit Agricole, HSBC and Rabobank have drafted the guidelines and submitted them to the International Capital Market Association in July.
But while social bonds might never be as big a sector as green bonds, that is no reason for investors to write them off.
“It’s clear that there is some scepticism around social bonds,” says Perezgrovas. “Green bond projects are more scalable so issuers can typically offer a larger issue size when printing bonds on climate change themes.
“But we have reached a stage in the evolution of this market where investors need to be more sophisticated than looking at classic risk-reward measures — saying that one bond is better than another because it is big and therefore theoretically more liquid, for example, and start quantifying the value of the sustainable and responsible capital markets component. In our view, social bonds will rank well in this criteria.”
Some issuers even believe that printing a social bond doesn’t necessarily mean that reporting has to be more complicated or difficult.
“The EYE bond is appealing to investors because it allows them to focus on results that improve lives,” says IADB’s Fan. “Every EYE loan (and it is the case with all of the IADB’s lending) provides transparent information on measurable results via a result matrix set at the loan proposal stage with subsequent progress monitoring reports on a regular basis.
“This transparency allows investors to monitor the progress of each EYE project.”