When NatWest came to market with its second social bond on February 23, it received a warm welcome from investors.
The €1 billion deal – the first from a British banking group designed to fund affordable housing loans – attracted more than €4 billion of orders from buyers in the UK and Europe, and priced inside the yield curve for NatWest’s conventional bonds.
The group has been a pioneer of social bonds in the UK, issuing its first deal – a €750 million bond from Royal Bank of Scotland targeting SME lending in deprived areas – in November 2019.
At the time, sustainable bond markets were almost exclusively focused on green deals. Since the start of the Covid crisis, however, the social market has taken off as supranationals, governments and other public sector borrowers rushed to raise funds to mitigate the impact of the pandemic.
“That prompted investors to revisit their mandates to see if they could expand beyond green, which has resulted in a big increase in demand for social bonds,” says Scott Forrest, head of treasury debt capital markets at NatWest Treasury Markets.
“We had a number of new funds coming into our deal. We also saw that more traditional names have an increased focus on ESG-specific mandates.”
Surge in appetite
Perhaps surprisingly, however, banks have been relatively slow to take advantage of the surge in appetite for social structures. While most of the big US groups have issued some form of social bond during the past year, deals from Europe have been few and far between.
Lupin Rahman, portfolio manager and head of ESG integration at Pimco, says this may be partly due to the increasing selectivity of buyers of sustainable bonds.
“Banks may be wary of pushing hard into this sector because they know that ESG investors are very detail oriented and will be very focused on the additionality component of the ICMA guidelines when looking at a social bond,” she says.
She notes that, for most large banks, a substantial portion of their lending is already focused on ESG themes such as low-income housing, minority-owned businesses, education and SMEs.
Banks are keen to demonstrate their social credentials
Lupin Rahman, Pimco
This is particularly true in the US, where banks are obliged to meet targets for lending to low and moderate-income neighbourhoods under the 1977 Community Reinvestment Act.
“When a bank issues a social bond, the key question is whether it is simply repackaging its existing lending activities or whether there is an additionality element,” she says. “I would say that for the bulk of issuance so far, it is the former.”
With NatWest’s latest bond, three-quarters of the funds raised will be allocated to existing loans made by the group to non-profit UK-based housing associations, while the remainder will be allocated during the next 12 months.
Others are less concerned about the additionality component of bank social bonds.
“It’s easy to question that, but you have to start somewhere when developing new markets,” says James Macdonald, a portfolio manager at BlueBay Asset Management.
He draws a comparison with early green bonds from the sector.
“That was probably what lending banks were doing anyway in areas such as renewable energy projects, but it allowed them to segment that and perhaps get financing at better levels,” he says.
“In the same way, with social bonds, this may be lending that banks would be doing anyway, but now they can structure the loans into these instruments. That boosts demand from investors, which means financing costs come down, and you get a circular benefit.”
Driver for change
At the same time, Macdonald warns that for the market to become “a meaningful driver for change”, banks will need to do more work on measuring the outcomes from social lending. “That is tough, and isn’t really being developed yet,” he says.
NatWest has taken steps to address this issue by publishing an interim impact report on its first social bond last July. Forrest says this was well received by investors.
“They welcomed the report because it provides a valuable traceability component,” he says. “Investors like to know that they are facilitating change.”
He adds that NatWest is keen to issue more social bonds – but whether other banks will follow its lead remains to be seen.
Social is where green was a couple of years ago
James Macdonald, BlueBay Asset Management
Macdonald says some may be more comfortable waiting until the market has developed a bit more.
“With green bonds there is a lot more standardization in terms of structures, measuring impact, etc, than there is with social bonds,” he says. “Social is where green was a couple of years ago.”
Despite the hurdles to issuance, however, Pimco’s Rahman is confident that the market will continue to grow, not only because of the general focus on ESG financing and lending, but also due to “the increasing focus in the US on diversity and inclusion”.
“This is important on both the consumer side and the investor side, so there are demand as well as supply drivers, and banks are keen to demonstrate their social credentials,” she says.
She also notes that recent announcements by banks such as Citi and JPMorgan of ambitious targets for the expansion of credit to minority and Black-owned businesses could enable them to explore new structures for social bonds.
So far, all bank deals have been in the use of proceeds format, where the funds raised are ring-fenced for specific projects – however, Rahman says lenders could also explore the popular sustainability-linked format, where coupon payments are linked to key performance indicators (KPIs).
“The targets we have seen some big banks setting could definitely be used as KPIs for an SDG-linked bond, so there is scope for banks to expand into that space,” she says.
