Tuesday 23 July 2019

Institutional investors are now turning their attention to social bonds as a way of integrating social impact into their portfolios. What are social bonds? And what are the challenges?


It is by now well known that institutional investors are increasingly integrating environmental, social and governance (ESG) criteria into their mainstream investment analysis. Pressure to deliver returns remains, and many are now turning their attention to another growth area in the sustainable capital markets: social bonds. What are they? What kind of issuers are looking at them? And what are the challenges ahead? 

Just as the green bond market is gaining in maturity and liquidity, issuance of social bonds, while behind, is starting to catch up. Unlike social impact bonds - whose payout to investors, usually from a government, is contingent on the success of the targeted social programme -proceeds from social bonds are channelled to areas such as education, healthcare, housing and employment. Similar in structure, then, to green bonds.

While a recent BNP Paribas roundtable found investors increasingly open to the idea of social bonds as a means of delivering positive impact while generating a satisfactory return, concerns remain. First, liquidity is low; second, impact reporting standards have not been settled. Until these concerns are addressed, issuers and investors may be cautious: the integrity of the market underpinned by robust frameworks is necessary for market development.

A growing asset class

Recent growth in social bond issues has been strong. Of the $608 billion in cumulative sustainable issuance, social bonds accounted for 6.5% of all issues between 2016 and year-to-date 2019. [1] This represents a five-fold increase in cumulative total social bond issuance between 2016 and year-to-date 2019, with the lion's share of these instruments (77%) being issued by sovereigns, supra-nationals and agencies (SSAs), followed by financial institutions groups (21%) and corporates (2%). [2] The dominance of SSA-led issuance at this early stage of the social bond market's development is not surprising, mirroring the early days of the green bond market.
The first ever social covered bond in Asia 
BNP Paribas was joint bookrunner on Asia's first social covered bond, supporting Korea Housing Finance Corporation (KHFC) to issue the €500m five-year bond in October 2018. Proceeds of the social covered bond are being used to finance KHFC's mortgage loan products, providing stable and long-term housing finance in Korea. The transaction is a landmark in the step towards driving forward sustainable finance in Asia, and will support the achievement of UN Sustainable Development Goal (SDG11) (Sustainable Cities and Communities). 
 
BNP Paribas data also shows the lead Europe has assumed in the social bond market. Euro-denominated issuance accounted for 67% of the total between 2016 and 2019, compared with 12% for USD. [3] Despite the rapid growth of social bond issuance volumes and a similar return and credit risk profile as conventional fixed income instruments, the market is still dwarfed by green bonds. This may change once more corporates begin issuing social bonds.

Why reporting is key

A lack of supply is hampering liquidity, and the lack of an agreed framework for measuring impact is hampering supply. 

"Investors are becoming more open to social bonds as an asset class, as they look to deliver a positive impact while simultaneously generating a satisfactory return "
Computing the impact of social bonds can be tricky, often because it can be a subjective exercise – but there are ways of doing it effectively. In its Social Bond Principles (SBP) guide, the International Capital Markets Association (ICMA) recommends that issuers exhibit impact through qualitative performance indicators, but also advises that they be complemented by quantitative performance measurements where possible. [4] Quantitative measurable data could be, for example, the sum of new houses built in a deprived area; or the number of disadvantaged people who have benefited from an investment made possible by a social bond (e.g. increased employment rates/healthcare access).

While investors need concrete data, the range of possible impact metrics and interpretations can be wide. The majority of institutional investors attending the BNP Paribas roundtable said they are taking a pragmatic approach towards social bond reporting. Those same institutions added they are willing to accept "output" type indicators (i.e. number of beneficiaries) as a first step, putting the emphasis on "traceability" of projects. However, improvements are being made to the actual "impact" methodologies, which are allowing for more granular social bond reporting by issuers. As this trend becomes more widespread, we can expect investors will increasingly buy into the asset class. 

Turning social bonds into an institutional asset class

The UN SDGs are a useful reference point in broadening the dialogue beyond green finance. While ESG frameworks are broad, the emphasis has so far been focused more on environmental than on social or governance issues. For example, the taxonomy envisaged under the EU's Action Plan on Sustainable Finance is primarily aimed at benchmarking environmental activities for companies rather than their societal impact. This is likely to evolve, as regulators increasingly turn their sights on societal challenges. Institutional investors are looking to allocate more capital into ESG projects, and social bonds should benefit. A BNP Paribas Securities Services survey of asset managers and owners incorporating ESG strategies reveals that more than nine in 10 of respondents believed that more than 25% of their funds would be allocated towards ESG by 2021.

Efforts are currently underway to standardise how data are collected and used in the social bond market, led by bodies such as ICMA. Through more expansive and better issuer education, the social bond market should flourish just as the green bond market did when more corporate issuers got on board. With institutional investors looking to diversify their investment returns and allocate their capital into more ESG projects, social bonds may just be starting the next chapter of their growth.

[1] BNP Paribas, Bloomberg (April 8, 2019)
[2] BNP Paribas, Bloomberg (April 8, 2019)
[3] BNP Paribas, Bloomberg (April 8, 2019)
[4] ICMA (June 2018) The Social Bond Principles 

Agnes Gourc
Head of Sustainable Capital Markets
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