Social bonds: financing the recovery and long-term inclusive growth

Summary

Abstract

With its triple impact on education, income and health, the Covid-19 crisis has exacerbated existing inequalities, both among and within countries. An additional 71 million people, concentrated in South Asia and Sub-Saharan Africa, could be pushed into extreme poverty in 2020 as a result of the pandemic.

The rise in socioeconomic inequality represents a real threat to financial stability, both at the macro and microeconomic levels of analysis. In this unprecedented context, social risks can have a significant impact on asset values and thus should increasingly be taken into account by investors. Moody’s estimates that US$8trn of the total debt it rates is subject to material social risks, i.e., four times the amount exposed to climate change risks.

A first possible strategy to integrate the social ‘pillar’ is to invest in social bonds, i.e., ‘use-of-proceeds’ fixed income instruments aimed at mitigating a specific social issue or at generating a positive social outcome. According to the most broadly accepted definition, a social bond is a regular or ‘vanilla’ bond that exclusively finances or refinances projects that address or mitigate a social issue, or that aim to achieve a positive social outcome.

The current period is especially propitious for this strategy, with the amount of new social bonds issued in 2020 ($142bn) more than eight times larger than in 2019. Remarkably, the European Commission, on behalf of the EU, successfully issued the first bonds of its SURE unemployment scheme under a social bond format.

Social bonds can be an optimal fit in the thematic pocket of investors’ fixed income portfolios to add diversification, to serve as a solid platform for engagement with issuers on social themes and as a guarantee of measurable impact reporting to avoid ‘social impact washing’. Long-term investors should consider investing in this nascent market to support its development and to take advantage of its future expansion.

As Covid-19 is a social cause that all market participants around the world can agree on, the moment is propitious to mobilize more private capital to meet the ever-increasing financing needs for social projects.

In this context, the development of the social bond market could provide opportunities for investors to align their strategies with key global challenges, above and beyond the pandemic. Although social bonds are not the only instruments with the potential to tackle social challenges, they do represent an optimal starting point for investors to actively engage with corporates and for the latter to start considering how their business models can contribute to the alleviation of social issues.