When it issued a 10-year social bond in June 2020, raising $100 million as part of its new Social Debenture Program, the City of Toronto broke new ground. The Program, first of its kind in Canadian municipal circles, attracted considerable attention among ESG investors who were drawn in by the purpose of funding projects in areas such as affordable housing, basic infrastructure and access to essential services. The landscape in social finance now seems like it could enter another phase, this time courtesy of the federal government. Is the worldwide boom in social bonds coming to Canada?
As the country emerged from a pandemic that reframed priorities for a number of investors, the Government of Canada used its April 2021 budget to announce a consultation that will be sure to turn heads. “Social bonds are an opportunity to connect socially conscious investors with Government of Canada bonds that support social objectives such as reducing homelessness and improving access to high-quality early learning and child care,” the Department of Finance wrote in the budget documents. Therefore, it proposed “to explore the potential for social bonds to complement the government’s existing debt program,” committing to look into the topic “as part of the Debt Management Strategy consultations this fall.”
Social bonds have burst onto the scene like few asset classes in the past. According to one estimate by Linklaters, a British-based law firm, they raised $163 billion worldwide in 2020, increasing ten-fold from 2019. The increase was in large part due to vast needs brought on by the COVID-19 pandemic and its socio-economic impacts.
Here are a few examples:
- The European Commission, the dominant issuer so far, secured 17 billion euros when it created a social bond for its “Support to mitigate Unemployment Risks in an Emergency”. It did not go unnoticed: interest among investors was so strong that the issuance was met with demand exceeding 230 billion euros.
- Ghana announced in May that it will be issuing up to US$1 billion in debt under a mix of social and green bonds.
- Chile issued a 20-year social bond worth US$1.7 billion.
- Since March 2019, Australia’s National Housing Finance and Investment Corporation has issued about A$1.2 billion in social bonds.
What do social bonds look like?
The social bond market aims to finance or re-finance “social projects”, which “directly aim to address or mitigate a specific social issue and/or seek to achieve positive social outcomes,” the International Capital Market Association explained in its 2021 edition of the Social Bond Principles (SBP). The framework was designed to provide promote transparency and integrity for market participants. The SBP essentially provide a list of social needs that can be financed with bond proceeds while stating four “core components”:
- Use of proceeds
- Process for project evaluation and selection
- Management of proceeds
In addition, the Social Bond Principles recommend the appointment of an external reviewer to ensure the alignment of the core components and the bond, a step that can involve obtaining a specific certification or a rating. (The SBP point out that bonds that integrate social and green projects should be referred to as Sustainability Bonds and are covered by a different set of principles.)
At this point in the article, readers might ask themselves about prices and returns. How would social bonds stack up against run-of-the mill bonds should the federal government take this route? In the absence of a track record in the Canadian market, we feel that an attempt at answering this question might lead us to speculate. However, investing in fixed income is, ultimately, part of a larger portfolio strategy where return differentials within other asset classes can be much wider.
The fall consultation on social bonds won’t be the first time that Ottawa has asked for input on social finance. In 2018, a steering committee issued 12 recommendations to “unleash the potential of social innovation to address Canada’s most pressing social and environmental challenges”. While not specifically mentioning social bonds, the 2018 report did allude to “social impact bonds” (SIB), a different bond-like instrument that links the structure of payouts to the realization of certain outcomes.
As is sometimes the case with financial products that are constantly evolving, this is where things can get tricky. There are no clear-cut definitions or standards, but SIBs are generally understood to be based on a model where investors provide capital upfront for a social program or initiative. If the outcome meets or exceeds certain predetermined targets — audited by a third party — the issuer, often a government or other public entity, reimburses investors a prearranged sum.
According to the Brookings Institution, 194 social impact bonds were issued worldwide between 2010 and 2020, representing upfront investment of US$421 million. Countries with the most bonds created were the United Kingdom, the United States, the Netherlands, Portugal and Australia. So far, Canada has only seen a handful of SIBs, and the capital being raised is relatively tiny compared with the amounts observed in the wider “social bond” market seen in other parts of the world.
Anticipating the level of demand
All this raises a question: what would investor demand look like should the federal government move forward with social bonds? Time will tell. In the first quarter of 2021 alone, social bonds issued worldwide raised US$90 billion, according to recent data from Moody’s. One trying to predict the appetite in Canada might look at last year’s social bond issued by the City of Toronto. For the $100 million bond – sold at $99.98 for a 10-year yield of 1.602 % -, the City recently mentioned that « expressions of interest were in excess of $400 million, with strong interest from the environmental, social and governance (ESG) community.” In a world where COVID has made many investors keen to explore social-themed opportunities, line-ups could be just as likely.