Cover story – Covid bonds
which specifically mention that all designated social projects should provide clear social benefits, however, the principle also leaves scope for refinancing operations. More importantly, these principles are not legally binding. In the context of the pandemic, this has actually been an advan- tage for issuers as it has offered flexibility to issue bonds with- out regulatory obstacles.
This growth in demand for social debt has been tangible for Kevin Ranney, director advisory services at Sustainalytics. The ESG ratings provider has established a taxonomy of ESG bonds, distinguishing between healthcare and socio-economic impact mitigation themes. “We have certainly seen considera- ble growth in bond issuance which fell on Covid 19. “Social bonds in general tend to see less issuance than green bonds but proportionally speaking we have seen a significant increase on the social side,” Ranney says. “The issuance has predominantly come from development banks although there has also been some corporate issuance.” For institutional investors, pension funds in particular, Covid bonds have a lot to offer. As the industry continues to gravitate further towards fixed income assets, with 47% of all defined benefit (DB) assets invested in bonds, according to the Pension Protection Fund’s purple book, investors are on the hunt for debt that offers a relatively higher and uncorrelated return with sustainability credentials. But why are Covid bonds offering higher yields and do these profits not stand in the way of the supposed sustainability of the asset? Are the proceeds really helping to tackle the pandemic or is all this just virtue signal- ing in an already heavily distorted fixed income market?
Research required One key obstacle for many investors is that due to the novelty and complexity of the investment strategy, the use of proceeds tends to be harder to measure as it would be with traditional social bonds, which in turn means that investors in purpose- led debt often cannot participate.
In a fixed income market that is more distorted than ever due to unprecedented levels of central bank intervention, assessing the credit worthiness of a new asset can be complex, as Stuart Trow, credit strategist at the European Bank for Reconstruction and Development, warns. “Both issuer and investor have to do quite a bit of credit work. That’s why there were relatively few green bonds early in the crisis as few investors or issuers had the bandwidth to deal with anything novel. It was far easier for them to deal with established names for which they might already have approvals for.” This meant that pension schemes with limited credit research capacities were initially hesitant to embrace the new trend. But Ranney argues that there is room for maneuver. “Given the urgency of the crisis, institutional investors in general are tending to be slightly more relaxed
These bonds have the potential to generate
competitive yields while also helping to meet financing needs created by the virus.
Anders Lundgren, NEST
about Covid-related social bonds. However, it is still important for them to establish the credibility of the bond, to ensure that there is a clear social bond framework that has the ICMA ele- ments, to ensure that there is a plan to be transparent about the use of proceeds.
“Institutional investors should also be looking for a second party opinion for each bond framework or issuance but it’s rea- sonable to be patient, and I think that is the case for many of them. If the second party opinion comes a bit later, sometimes after the issuance, that is likely to be ok for many industries,” he adds.
Indeed, some of the world’s biggest pension funds have been Issue 94 | July 2020 | portfolio institutional | 23
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