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Social bond surge appears here to stay as COVID-19 crisis shifts funding needs

The COVID-19 pandemic has led to surging demand for bonds that finance social projects. Market participants say this spike is likely to last beyond the crisis as the coronavirus has given the social bond market a sense of purpose and clear goals that it previously lacked.

Social bonds are debt instruments that raise money for social projects, including affordable housing, health and education. They have long been the poor cousin of green bonds, which fund environmentally friendly projects such as wind farms or solar power. Green bond issuance has soared in recent years as investors lapped up debt focusing on climate change.

But with the onset of the coronavirus, that demand flipped. Social bond issuance for 2020 totaled $11.58 billion as of May 15, compared to just $6.24 billion in the same period of 2019, according to an International Capital Market Association analysis of the Environmental Finance database. Total social bond issuance in 2019 was $16.70 billion.

Demand for sustainability bonds, something of a hybrid between green and social bonds, has also surged. It reached $25.62 billion in the year through May 15, compared to $13.64 billion in the same period a year earlier. Total sustainability bond issuance stood at $43.49 billion in 2019.

Green bond issuance, on the other hand, has dropped sharply. It totaled $53.54 billion in 2020 as of May 15, compared with $84.09 billion in the same period of 2019.

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Social bonds gain popularity

Much of the social bond issuance is coming from development banks. African Development Bank listed a $3 billion "Fight COVID-19" social bond in London April 3, the proceeds of which will be used to support struggling African healthcare systems in the wake of the coronavirus. The World Bank's International Finance Corp. in March issued a $1 billion three-year social bond designed to boost financing in healthcare systems in developing countries.

The European Investment Bank, the EU's main lending arm, issued a €1 billion sustainability awareness bond on April 3 that was seven times oversubscribed.

The Nordic Investment Bank issued a €1 billion three-year response bond in Helsinki and a three-year 4 billion kroner bond in Stockholm to finance healthcare investments and increases in social security spending in Nordic and Baltic countries. Lars Eibeholm, vice president and head of treasury at the bank, has "no doubt" the strong increase in demand for social bonds is here to stay.

In the past, the social bond market was hampered by a lack of clear definitions and targets. The pandemic could change that by providing concrete goals, Eibeholm said.

"Now we will have some easy targets, easy things to measure and therefore companies will issue bonds addressing these targets and investors will look very positively at this," he said.

Bond issuers will increase their focus on social issues including funding to alleviate unemployment and to finance hospitals and medical equipment in the next six to nine months as economies rebuild, said Christopher Flensborg, head of climate and sustainable finance at Swedish lender Skandinaviska Enskilda Banken AB (publ). Social bonds in the past have raised funds for small, medium-sized and micro businesses to create new jobs.

Fund managers may also create new specialized investment funds that will concentrate on investments with positive social outcomes, Flensborg said.

'Social washing' risks

The flurry of bonds linked to social causes on the market will also face scrutiny from investors, who will look at the long-term objectives of these bonds to ensure they fulfill a social mandate, Eibeholm noted.

"Investors are also afraid of social washing [or] just buying everything that comes out," he said. "Today you can say that all government bonds and all increased funding requirements are somehow a response to the crisis," he said.

Social bonds are usually issued to deal with long-term concerns, but COVID-19 creates emergency funding needs, experts noted.

"COVID-19 is a little bit of a different animal," Flensborg said. "It's an emergency and consequently a number of people might do faster financing to make sure they get urgent funding."

Investors will expect issuers to be transparent about how they intend to spend the funds raised through social bonds to ensure the money is being used appropriately, said Peter Munro, head of investor relations for sustainable finance at the European Investment Bank.

"From an investor's point of view, while I am sure they will welcome issuers who react to the crisis, asset managers will continue to demand information on the outcomes and the impact," Munro said.

To promote transparency and integrity in the social bond market, the International Capital Market Association, or ICMA, established guidelines for issuing social bonds. Issuers have to explain exactly how they will use the money raised from the social bond issue and provide yearly updates. But the guidelines are voluntary, and a number of institutions have issued COVID-19 response bonds that are not in line with ICMA's principles and thus are not subject to the same investor scrutiny.

Eila Kreivi, director and head of the European Investment Bank's capital markets department, said investors need to consider the social impact of their dollars, regardless of how the investment vehicle is labeled. Investors need to question companies about their actions during the pandemic — how they engaged with their community, how they treated clients and employees.

"Textile companies have started to produce masks, perfume producers have started to produce sanitizer instead of perfume so lots of people are trying small things,” Kreivi said. "Did you furlough your employees and cash in government support or did you borrow money with the pretext of COVID-19 and then use it to pay dividends? These are questions that investors should be starting to ask."