CSR bonds: Are sustainability bonds better than green?

The green bond market may be experiencing a record year of issuance, but some bankers say the social bond and sustainability bond market could well eclipse it. Sustainability bonds allow issuers to use the proceeds for both environmental and social projects – a hybrid of a green bond and a social bond. 

Suzanne Buchta, BAML

In May Starbucks issued a $500 million sustainability bond to fund sustainable programmes for coffee supply chain management. In June New York City Housing Development Corporation (HDC) launched $590 million of Sustainable Neighborhood Bonds that allows investors to identify and invest directly in the socially beneficial projects financed by HDC. Then in July Dutch bank BNG issued a €1 billion social bond to lend to sustainable housing associations.

Navindu Katugampola, head of green and sustainability bond origination at Morgan Stanley, says, due to the flexibility offered by sustainable bonds, they are likely to produce a larger market. Social bonds allow for a much broader range of projects, which in turn is more encouraging for corporates.

“Every large company has a sustainability department and a focus on Corporate Social Responsibility, and social bonds or sustainability bonds allow companies more freedom around the range of initiatives to support via a bond,” says Katugampola. He points to Starbucks’ bond. The company initially planned to launch a green bond but due to the nature of its proceeds also being used for financing for farmers, a sustainable bond made more sense.

Investors also may be more open to sustainable bonds, in spite of the focus on climate change solutions. They may be more familiar with concepts of socially responsible investing than they are with green bonds. Much of the impetus for BNG’s transaction came from a strong European investor base. 

The appetite for use-of-proceeds concepts is increasing as, for the first time, bond investors are realizing they can now vote with their fixed income dollar feet. “We know that equity investors, if large enough or joined together, can vote to affect change but typically fixed income investors don’t have a say – they buy based on credit quality,” says Suzanne Buchta, managing director, green bonds, at Bank of America Merrill Lynch (BAML). “But all these bonds offer them a chance to have an impact in a mainstream way.  And in a world with more millennials wanting to effect positive change, that trend is only going to increase.”

The growth of the social bond market could also have a positive impact on the social impact or pay-for-success bond market. Social impact bonds have increased in number also over the last few years. To date there have been some 60 issues. They tend to be public/private partnerships and are much smaller in size. They are designed to provide a solution to a particular social issue, and only return the principal and interest if outcomes are met. An example would be UBS Optimus Foundation’s Development Impact Bond in Rajasthan where proceeds are specifically targeted at getting girls into school and improving educational quality. 

Caroline Anstey, global head of UBS and society at UBS, says she expects to see more in the way of this blended finance, but adds that the challenge is taking these bonds to scale. She suggests the future could well involve funds of funds, which could then attract larger institutional investors. Most social impact bond deals currently attract investment from private individuals and foundations. 

Navjeet Bal, vice president and general counsel at Social Finance in the US, says institutional investor appetite is coming. The firm is raising capital from two institutional investors. 

While there are concerns that the importance of social impact bonds may be overtaken by the larger, more institutional, social bond and sustainable bond market, Buchta explains that, “social bonds will allow fixed income institutional investors the opportunity to become more comfortable with the concept of investments where the proceeds are used for social good,” she says. “Social bonds and green bonds go through a strict approval process that investors understand. That could open them up to conversations about other potential investments like pay of success financing.”

It could also open banks up to considering other structures more akin to pay-for-success financings elsewhere in their business lines. “Potentially if, in underwriting these bonds, we find investors are interested in exploring using funds for social good, then we could think about taking the time to get an approval process in place for something more complex.”