A good rule of thumb when it comes to new asset classes is that typically, when Bank of America gets involved in something, it's a good time to start paying attention.
In May, it became the first US bank to issue a $1 billion corporate social bond entirely dedicated to fighting the impact of the Covid-19 pandemic.
According to the International Capital Market Association (ICMA) social bond issuance for 2020 totalled $11.6 billion as of May 15, which is significantly higher than the $6.2 billion issued over the same period of 2019. The total for 2019 was just $16.7 billion.
Bank of America announced that proceeds from the offering are to be allocated to healthcare industry lending in the firm’s global commercial bank; specifically, not-for-profit hospitals, skilled nursing facilities, and manufacturers of healthcare equipment and supplies.
“The world is in a fight against Covid-19 and we are committed to doing our part by supporting the companies and professionals on the front lines,” said Bank of America vice chairman Anne Finucane. “The proceeds from this offering will help deliver critical resources for the companies involved in the testing, diagnosis, treatment and prevention of this insidious virus, while providing investors an opportunity to join us in this all-important effort.”
Maarten Vleeschhouwer, seconded national expert on sustainable finance at the European Commission (EC), notably on the EU taxonomy, also said that the Commission is definitely looking with interest at this flurry of social bond issuances targeting Covid-19 specifically. "It is very good to see markets try to do the right thing, get together and start issuing social bonds specifically geared towards Covid-19. In general, we view it as a very positive development."
Use of proceeds
The Bank of America and the EC are one thing, but given that social bonds have been issued far and wide within a very short timeframe, the potential for greenwashing, and for the misuse of funds, is high.
With that in mind, we asked a number of sources how far social bonds directly targeted at supporting those most in need as a result of the pandemic could go, and whether proceeds could – or should – be used for other projects.
Overwhelmingly, respondents suggested that proceeds from Covid-19 allocated social bonds should be used for redevelopment not specifically related to fighting the virus. The consensus suggests that the most important caveat is that the use of proceeds, if not directly financing the development of vaccines or something along those lines, complies with ICMA'ss social bonds principles.
|"It is good practice in a social or green bond for an issuer to indicate a range of potential project categories"|
"It all comes down to what the issuer said in its documentation," said Nicholas Pfaff, head of sustainable finance at ICMA. "It is good practice in a social or green bond for an issuer to indicate a range of potential project categories– because a few years down the line it may be a very different world.”
According to Pfaff, if the new use of proceeds is a clearly recognised social project category then there should be no problem – but there is of course the risk that, in extreme cases, the money may be used elsewhere altogether.
Denise Odaro, head of investor relations at the International Finance Corporation (IFC), goes as far as to say that it is not plausible even to think of the question as “what to do with excess funds”. When you issue a social bond, and the use of proceeds are partially going to or expected to go to Covid-19 related projects, and there is a surplus, that surplus has to go to other social projects by definition.
"It is not a credible social bond unless the use of proceeds is exclusively for social projects, which by the definition of a social project in the Social Bond Principles could include those related to alleviating the Covid-19 crisis. To illustrate this, if 70% of the funding an entity has raised goes to Covid-19 projects, the 30% balance has to go to other social projects," she said.
“Ultimately, the volume and type of eligible projects in an issuer’s pipeline should determine its social or sustainability bond programme. Establishing eligibility and creating a framework ahead of issuance is good practice, as recommended by the principles,” she added.
It may not be that difficult to convince an investor anywhere in the world to invest in a bond that will tackle climate change, or other forms of green finance. However, for some investors the concept of a social bond will fluctuate, and things may not be so simple, meaning the need for explicit terms and conditions will be greater than a simple green bond.
"If you are a pension fund in Sweden, or an asset manager in the Netherlands, your definitions of social and focus on target populations will vary greatly depending on who they are, where they are and what they're looking at," said Jacob Michaelsen, head of sustainable finance advisory at Nordea in Denmark.
|"The Covid-19 crisis has really managed to highlight the social component and make it accessible"|
"I think it is fair to say that the ‘social’ discussion has, to a certain extent, previously been neglected as most investors have put climate ahead. However, the Covid-19 crisis has really managed to highlight the social component and make it accessible," he said. "Although it is worth noting that this builds on the now common acceptance of ‘use of proceeds’ that the green bond market has championed in recent years. That has really helped set the scene for social bonds to take off this year."
A patchwork blanket
An important aspect of this concept is which principles the issuer abides to, of which there are several. IFLR has covered in great detail the taxonomy of ESG, which varies region by region and is furthest along in the EU. It is essential to remember that all social bond principles are simply guidelines. Because of this, many issuers opt against using concise social bond principles.
"Some decide not to go down the official social bond route, but instead publish a framework that adheres to the best practice of social bonds, without the label," said Herve Duteil, chief sustainability officer at BNP Paribas Americas. "Then you have those typically FCA-approved, typically multilateral, development banks that issue a different format with different strings attached."
Most choose to adopt a standard, but because there are no mandatory standards for how social bonds should look, there is a large grey area. The EU is working on building standards that would resolve this by building out a taxonomy, but the primary focus of the taxonomy is green bonds.
Other examples include S&P Global’s Positive Impact Scorecard toolkit, which looks at the different sustainable products that companies offer and assesses the extent to which those activities are aligned with the UN Sustainable Development Goals, which of course includes social outcomes and objectives.
"What is important is applying a set of principles to understand whether the use of proceeds for bonds are providing some form of social good," said Richard Mattison, CEO at Trucost ESG Analysis, part of S&P Global. "What is almost more important, is that it is pretty difficult to prove the use of proceeds are providing any [social good] additionally."
"It can be quite tricky. Take a very simple example of a social bond being raised to enable more widespread access to the internet," he explained. "If that bond is being raised in the US there's pretty much none, but if that bond is raised in a developing country where internet access is still very low, then there is. This could be called the social problem."
What is a social requisite in one location may not be in another. The US may be suffering from the Covid-19 pandemic, but that is not to say the redevelopment of its already-developed healthcare system would be aligned to social bond principles.
Additionally, organisations such as the World Bank already have very clear social mandates so do not need to follow the taxonomy route or abide to existing mandatory standards. "It is already in their organisational mandate to have an impact on society for this type of work. So even though the perfectly fleshed-out social bond format is not there, they are able to issue social bonds because they were quickly responding to an emergency situation," said BNP's Duteil.
|Case study: Guatemala|
In late April, the Republic of Guatemala issued a $1.2 billion sovereign dual-tranche bond issuance, with proceeds to be used to finance or refinance, in whole or in part, eligible social investments which are directly or indirectly related to the country's Covid-19 prevention, containment and mitigation efforts.
This was the first social bond in Central America and the Caribbean, and the first example of a Latin American country including Covid-19 response efforts among other eligible social projects in the use of the proceeds of a sovereign social bond issuance. The issuance also took into consideration ICMA's Social Bond Principles.
"These social bonds are aligned with the social bond principles. Everything they identify as use of proceeds qualifies as social bond principles, but that doesn't mean that they will use these entirely for a Covid-19 direct response effort," said Hugo Triaca, partner at Clifford Chance, who represented BofA Securities as global coordinator, sole bookrunner and social bond structurer for Guatemala. "Some of the other issues or programmes that they will finance with this issuance were already approved in the budget and will indirectly help cope with the recovery effort."
"In the use of proceeds there are subsets including the direct Covid-19 response and budgets food security, with a budget that includes social or related investments for the Ministry of Education," he added. "Some investments will address basic infrastructure needs, including investments to improve the situation seen in hospitals and infrastructure around the health industry."
The necessity to act quickly has led to some pandemic response bonds not being appropriately labelled as social or even Covid-19 bonds. This is potentially damaging to the bond itself, and will lead to confusion.
"One of the major benefits of the label is the transparency disclosure, but in this time of urgency, issuers are seeing the process to label as a time constraint and have just issued where there could have been an opportunity to issue green, as we saw with Chile," says Justine Leigh-Bell, deputy CEO at the Climate Bonds Initiative.
For example, some of the Covid-19 related issuances coming out of China have been directed towards healthcare or rescuing jobs, or ensuring that the country can sustain its economy going forward. "But interestingly, in some of these Chinese pandemic bonds we have seen financing for renewable energy assets that may be contributing to the country's 'new infrastructure plan', that promotes low carbon development as a response to the crisis," she added.
"Who knows to what extent much of their pandemic related debt is going to be pushed in that direction? We are still trying to get our heads around what’s being financed," she said.
Generally speaking in the sustainable finance market, whether it be social bonds targeting Covid-19 or not, there is always the risk of a project turning out to not be as sustainable as initially thought. "That is definitely something to be aware of, but if you look at the social bonds issued so far that target Covid-19, many of them do follow the social bonds principles that are administered by a commodity market-based principles," said the EC's Vleeschhouwer.
Given that ICMA has issued specific Covid-19 guidance, and a large number of issuances have come from multilateral development banks – which who tend to be very trustworthy partners – the risk is small. "This risk is always there. It is a fair question and it is good to be aware, but we've not heard or seen anything negative yet," he added.