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The Emergence of Social Bonds As a New Rating

The COVID-19 pandemic has dragged countries around the world through a period of economic disruption, the depths of which have not been seen since the Great Depression. Increased unemployment, rising fatality rates and strained health care systems have placed a spotlight on a future fraught with social risks. In parallel, corporations and financial institutions have been looked to for leadership in addressing these unforeseen challenges. 

Positive Social Outcomes

S&P research shows that this call for a greater focus on mitigating social risks has spilled over into the capital markets, particularly through the rapid rise of social bond issuance — even as credit conditions have weakened sharply.

Social bonds have emerged as an unlikely tool in the economic fight against the virus to address the demands of consumers and communities that are increasingly aware of current social issues. The International Capital Market Association (ICMA) defines social bonds as those whose proceeds fund new and existing projects with positive social outcomes, such as improving food security and access to education, health care and financing.

Although historically only constituting a relatively small part of the overall sustainable debt market, social bond issuance has more than quadrupled this year — with growth outpacing

the more mature green bond market. The trend could foretell a pivot away from a historically climate-centric sustainable debt space and reflect a diversification of sustainability objectives financed by investors. 

And, while the COVID-19 pandemic may have precipitated this recent surge, the appeal of social bonds as a sustainable finance instrument may endure long after the pandemic’s effects have subsided. According to the Climate Bonds Initiative (CBI), of the $400 billion in sustainable debt issuance in 2019, social bonds constituted approximately $20 billion — just 5% of market share. But, from this low-base, their share is growing rapidly: According to Morgan Stanley, $32 billion of “social” and “sustainability” bonds were issued in April 2020 alone. 

This also marked the first month during which social and sustainability bond issuance surpassed green bonds.

Impact of COVID-19

Undoubtedly, much of this rapid growth can be attributed to the effect of the COVID-19 pandemic, which has accelerated the issuance of social bonds to finance both public and private responses and create positive social outcomes, especially for target populations.

In March 2020, ICMA underlined the relevance of social bonds in addressing the coronavirus pandemic and provided additional guidance for eligible social projects, which could include coronavirus-related health care and medical research, vaccine development, and medical equipment investments. 

The increased scope of projects eligible to be considered under the social bond designation likely led issuers, particularly supranationals, to become more active in the space. 

In March 2020, the International Finance Corporate completed its largest social bond issuance since its social bond program was launched in 2017 to finance its response to the coronavirus. Soon after, the African Development Bank launched a $3 billion “Fight COVID-19” social bond, which, according to the Institute of International Finance, was the world’s largest dollar-denominated social bond transaction to date.

First Country to Issue a Sovereign Social Bond

Furthermore, In April 2020, Guatemala became the first country to issue a sovereign social bond aimed at financing COVID-19 response efforts. These recent issuances indicate that the pandemic has not turned issuers’ or investors’ attention away from sustainable finance; in fact, interest in this space seems to be expanding. We do not believe that market engagement in green bonds or loans will tail off entirely. 

However, as the sustainable debt market grows, we anticipate social bonds will make up a significantly larger share. As calls for transparency become louder, social bond reporting and robust disclosure practices will only gain importance. 

Historically, green bonds have been more popular than their social bond counterparts, partly because their impact can be tracked using more easily quantifiable and science-based metrics (i.e., a reduction in greenhouse gas emissions or energy use) that are well-understood by investors. 

This mitigates the risk of “greenwashing” — where a company misuses the “green” label to overstate the true environmental benefit of a transaction and, in doing so, misleads market participants. The standards surrounding social bonds, however, are more complicated because assessing social impacts tends to be more qualitative and less standardized than for green projects. 

The Risk of ‘Social Washing’

As interest in social risks grows, particularly amid the COVID-19 pandemic, investors now face a new issue — social-washing — which, in our opinion, could arise if the proceeds are labelled as “social,” but the implied social benefits are questionable. In order to standardize the definition of social projects and mitigate this risk much like it did for the green bond market, ICMA developed a set of Social Bond Principles (SBPs) in 2018. These were later updated this year. 

The principles encourage companies to define what they consider “eligible projects,” structure their transactions to avoid misallocation and regularly report on use of proceeds. Adherence to the SBPs is generally valued as a sign of credibility and market integrity given enhanced transparency and standardized disclosure practices. 

However, the guidelines are voluntary, and unlike for green bonds, where around 80%-90% of issuances are aligned with the Green Bond Principles, a number of institutions have issued COVID-19 and other self-labelled social bonds that are not aligned with ICMA’s SBPs.

In addition, with so many issuers currently accessing the social debt market, speed to market has become the most important factor, with many issuers foregoing external verification/review. Therefore, while we are seeing growth in social debt for crisis response, improvements in tracking and disclosure are experiencing a significant lag. As social bond issuance picks up, we anticipate expectations for transparency will grow while social bond impact reporting will be imperative to developing a more standardized social bond market.

Although still small, we believe the social bond landscape is growing and evolving rapidly and that the correct steps are being taken to ensure sustained capital flows toward socially beneficial objectives. The recent surge in social bond issuance to address the COVID-19 pandemic has given investors the rare opportunity to evaluate an entity’s commitment to its stakeholders — including employees, customers and communities — in the short-term. 

Improved transparency and reporting practices will ultimately help reduce some of the social bond risks, including social-washing, and solidify investors’ confidence in the asset class as it grows, ultimately propelling further issuance.

Lori Shapiro

Sustainable Finance Associate at S&P Global Ratings

Lori Shapiro joined S&P Global Ratings in 2017, and has been on the Sustainable Finance team since February 2020. Since joining the team, Lori has led thought leadership on social risks and on the evolution of the sustainable debt market.

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