Tuesday, 22 January 2019

Putting people first

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  • Putting people first

There are signs that the market for socially responsible investment is about to take off – but can “social bonds” ever match their green cousins?

Hand-wringing at January’s World Economic Forum summit in Davos about non-financial risks to growth suggests policymakers may finally be acknowledging that they can no longer ignore an investment trend hitherto confined to the realms of altruism.

The WEF’s Global Risks 2015 report launched at Davos indicated emphatically that if the risks facing global growth of the past 10 years were largely macroeconomic, those in the next 10 will be social and environmental.

This watershed suggests that, henceforth, socially responsible investment (SRI) is likely to be seen as not just the wishful thinking of financial tree-huggers with a guilt complex – but more as a crucial tool of structural reform.

The United Nations’ landmark Principles of Responsible Investment (PRI) launched in 2006 have been instrumental in raising the profile of responsible investment, but the running in this area has been made by the market for green bonds, which in 2015 could top US$100bn.

Advocates of SRI are now growing confident that the business case for investments that have a positive social impact is proven – and the market for themed “social bonds” may be about to take off after a benchmark US$500m Inter-American Development Bank issue in September.

The four-year deal inaugurated the IDB’s Education, Youth and Employment (EYE) bond programme aimed at poverty reduction and social equity in Latin America. If not the first benchmark issued by a multilateral development  bank to support social development, it certainly signalled that the MDBs are responding to investor demand for large, liquid SRI fixed-income products.

IDB executive vice-president Julie T Katzman indicated that the key to the future lies in that scale of demand. She said: “The increased depth of the socially responsible investing space made issuing the EYE bond possible at fully competitive rates. There are now sufficient investors who want Triple A paper and something that aligns with their values.”

In the fixed-income world, SRI long merely meant “negative screening” – but “positive” fixed-income instruments have now emerged. The World Bank has been issuing benchmark bonds since 2007 with the aim of tackling poverty and the market for themed social bonds is picking up. In 2013, the first real non-green benchmark SRI bond (US$700m) was issued by the International Finance Facility for Immunisation (IFFIm) and in 2014 transactions with a social theme included Lloyd’s £250m Environmental, Social and Governance (ESG) bond.

One reason themed social bonds have lacked the profile of their green cousins may lie in problems of terminology: SRI as an acronym is used in many ways that take in a large number of investment permutations.

Nonetheless, by any standard SRI growth has been dramatic. Assets under management of signatories to the PRI initiative surpassed US$45trn in 2014. Eurosif, the pan-European SRI membership organisation, said in 2014 that systematic ESG integration into investment strategies covered €2trn of all European man­aged assets. Its counterpart in the Americas, USSIF, said US$6.57trn was invested according to SRI strategies by the end of 2013.

It is SSA that have driven this phenomenon and the European Investment Bank has been a pioneer, issuing more than US$5.6bn of green bonds in 2014. Other prominent names in the green bond space are Skandinaviska Enskilda Banken and Germany’s KfW.

Given the broad terminology in this field, KfW advocates a more standardised approach towards the different ESG criteria. KfW treasurer Frank Czichowski said: “Traditionally we had an approach that was geared more towards climate and environmental protection, but there seems to have evolved a consensus in the market that the emphasis should be more equally distributed between the environmental, social and governance aspects. It is very difficult for issuers otherwise.”

Europe has emerged as a global driver in this area and expanding SRI in the US is now an unstated priority of the UN and ESG professionals. But within Europe there are sub-regional differences, with Scandinavia an influential force and even World Bank issuance driven by Swedish demand.

Lars Eibeholm, head of treasury and vice-president at the Nordic Investment Bank, said: “There has been political support for the environment and environmental investments in the Nordic area for many years. If you take as an example the wind power industry, this is an area where we have a leading edge. We also have hydropower energy supply in the Nordic area. So, from that starting point, there has always been political interest in green energy and the green economy.”

So are principles – or profits – driving the growth of the SRI market? The clear consensus among SSAs is that issuers, investors and politicians are all behind the growing demand.

Eibeholm said: “It’s a mixture of investors, banks and politicians. The main driver behind green bond growth during the last couple of years has been investors, but also banks as intermediaries that actually facilitate the market. We have also seen corporates taking advantage of issuing green bonds, not only the supranationals. Further, we have seen growing political will, lately with the Green Climate Fund, behind efforts to create green, sustainable economies.”

The motives of all these actors vary – from ethical concerns to the hunger for new business. Marc Schublin, the EIB’s director of corporate responsibility, said: “There is more morality in the market among investors in clean products – clean not just from an environmental but also from a financial point of view. This is the morality story. There is the consultancy driver, where ratings agencies active in this sector say this is the future. And there is the market itself, a whole industry behind this, where everybody knows something needs to be done.”

Nonetheless, the SRI space faces key challenges – not least is the unresolved debate about the competitiveness of paper that ultimately has social, not financial, underlying objectives.

A huge amount of attention has been given to the trade-off between social and commercial benefits. Last year, research by the Smith School of Enterprise and the Environment at the University of Oxford and Arabesque Asset Management suggested that a focus on ESG boosts share performance.


Other challenges SRI faces concern standardisation and transparency, highlighted by a major World Bank review of policies to safeguard people and the environment in its projects. Critics such as the Washington-based Bank Information Center (BIC) say planned changes could weaken the application of standards.

“Under this review many positive things are happening in the World Bank’s policy, but we believe the specific requirements to ensure the application of these standards for a project are being weakened,” said Christian Velasquez-Donaldson of the BIC.

A key question has to be about the limited approach to ESG of the heavy-hitting credit rating agencies such as Fitch, Moody’s and Standard & Poor’s. In 2014, they were accused at a conference run by the PRI initiative of treading water on ESG factors.

These challenges aside, a consensus among SSAs is that SRI could take off in 2015. There is a growing demand for scale in impact investing and in a report on trends to watch in 2015, Linda-Eling Lee, global head of research at ESG ratings agency MSCI, identified the search for large-scale exposure to positive social impact through listed equities.

Laura Nishikawa, executive director ESG research at MSCI, said: “If you look at impact investing from a market perspective, you are talking about private equity, venture capital, start-ups, private-sector players, lots of public-private partnerships. What we are seeing from institutional investors is demand for a much larger scale of impact. In terms of which issues have the biggest project pool to draw from, the SSAs have the potential to lead in this area.”

What market participants really want to know is whether themed social bonds can match the evolution of the green bond market.

Czichowski of KfW said: “If you look at the so-called themed bond market there is a clear dominance of bonds focusing on climate and environment. It will be interesting to see whether a separate themed bond market will evolve around social issues. Investors are looking for liquid bonds and that is why everybody is focused on the E of ESG, but it is early days as to whether this will develop in the other areas too.”

“I think that one day, the optimal balance of that combination – credit, and also social and environmental – will achieve the lowest funding costs and the best return for project owners and society”

Schublin at the EIB agrees that the S of the ESG market has been neglected, and indicates that this is something the bank is actively addressing. “We are working on this, people are looking at special measures – at least at a trial to test the product because there is an appetite among investors. A green bond equivalent on the social side could be feasible but is not yet being done. For the time being we are developing the green side, but I firmly believe that social bonds will be next,” he said.

But any potential market for social bonds faces complex challenges. According to MSCI’s Lee, features of the green bonds market fuelling growth – well-understood risk and return characteristics, a transparent framework to define “green”, and increasing liquidity and scale – remain elusive for social impact investment.

Nonetheless, with the extension of ESG integration, a thriving green bond market and encouraging signals on social bonds, is it possible to imagine a world in which all investment will eventually be SRI?

There is little doubt that pressure from civil society for this is growing, but Eibeholm at NIB suggests that, ultimately, there may be a competitive logic to engaging in socially responsible investments.

He said: “We have for many years been providing both a credit analysis and a sustainability analysis for our projects. These two go hand in hand, and both criteria need to be assessed before NIB can finance a project. I think that one day, the optimal balance of that combination – credit, and also social and environmental – will achieve the lowest funding costs and the best return for project owners and society.”

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