Sat, Oct 24, 2020 at 5:50 am
The European Union offered its first social pledge – as in ESG’s initial intermediary: environmental, social and governance – in a two-part sale of 17 billion euros ($ 27 billion) . The investors were ravenous.
In the end, the offer was oversubscribed 14 times. Orders topped 233 billion euros, making it possibly the biggest debt sale ever. This is easily double the previous record demand of 108 billion euros for Italian debt in June.
There are a number of reasons why the social bond of the EU was so in demand. On the one hand, it carries the block’s AAA credit rating. It is also the EU’s first joint debt offer since the bloc accepted its pandemic resumption deal. That this is a social bond – the fastest growing segment of sustainable debt, the asset class that also includes the trillion dollar green bond market – is significant.
Why is it important? Well, it’s complicated. It is certainly not a bad sign for sustainable finance that the demand for AAA-rated social bonds exceeds supply by more than an order of magnitude. It’s also not bad for the bond issuer – demand far greater than supply will cause prices to rise, resulting in a lower yield. It also gives new issuers an incentive to offer their own sustainable debt, whether they are companies, supranational organizations such as the World Bank, or sovereign entities.
But I wouldn’t necessarily call this fleeting request a good sign, either. A seller’s high price also runs the risk of being too high a price for the buyer, for example. A sustainable debt premium could in fact boost some asset managers, who (rightly so) have a mandate to seek the best performance of bond funds for asset owners.
A structurally underserved market
A 14 times oversubscribed sustainable debt supply also indicates a structurally underserved market. In theory, the EU could have sold not 17 billion euros of AAA-rated social bonds, but rather 200 billion. This is, for me, an offer of unsustainable sustainable debt. This creates the possibility that buyers will take their debt appetites elsewhere, whatever their intentions.
Durable debt issuance topped $ 560 billion last year and has already reached $ 460 billion and beyond in 2020. The sale of EU social bonds indicates that there is sufficient demand for a market several times larger than that. If the market becomes 10 times bigger, we should be looking for it to replicate existing debt market instruments – and that means securitization.
Currently, almost all viable debt is rated B or higher, which means its issuers are generally considered low credit risk. On a much larger scale, however, we should expect to see a wider range of credit ratings. If this happens, there is potential for durable secured loan bonds. ESG-themed CLOs already exist, although their “green” qualities are largely at the discretion of the arranger; there are no regulations setting specific criteria and the volumes are quite low.
A much larger market might give some investors pause, as over-securitization was a major factor in the 2008-2009 global financial crisis. But if that’s part of achieving the five or ten times the scale that buyers of durable debt are looking for, then a little speculation might be. . . well, durable. BLOOMBERG