by David Zahn, CFA, FRM, Franklin Templeton Investments
The European Union (EU) came together to deliver a sweeping pandemic aid package in July and has come together again with the issuance of “social bonds” to further fund economic relief. Social bonds are aimed at funding projects that benefit society—in this case, programmes for workers displaced by the COVID-19 pandemic.
Social bond proceeds will be directed towards the Support to mitigate Unemployment Risks in an Emergency (SURE) programme (a €100 billion programme), which provides loans to EU member states to cover costs directly related to the creation or extension of national, short-time work schemes, helping to protect jobs. The of 10-year and 20-year instruments (€17 billion issuance in total) saw record demand of €233 billion (US $276 billion), illustrating strong investor interest in these types of instruments.
Both and social bonds have been exploding in popularity over the past few years. The COVID-19 crisis seems to be drawing even more attention to this space as investors seek environmental, social and governance-driven (ESG) investment solutions. In April alone, US$12.7 billion of social impact bonds were issued around the world, more than the amount raised for all of 2019, putting the year-to-date total to around US$85 billion.1
While there has been bond issuance at the regional level in Europe, these new social bonds represent the first big EU-wide issuance, and of such high-quality—with AAA ratings by several credit rating agencies. We think many investors both inside and outside of Europe will buy these bonds to diversify individual country risk and will consider them as “safe havens” given the high credit rating.
The social bonds also offer attractive yields. The 10-year bond was priced at three basis points above mid-swaps, equivalent to +36.7 basis points over the conventional 0.00% German Bund due 15 August 2030, and the 20-year bond was priced at 14 basis points above mid-swaps, which is equivalent to +52.1 basis points over the 4.75% Bund due 4 July 2040.2
Johannes Hahn, European Commissioner for Budget and Administration, called the issuance the “first step towards entering the major league in global debt capital markets”.3
Will the new EU debt become the benchmark bond for Europe? Maybe—but most benchmark issuers issue bonds on a regular basis, whereas the EU issues bonds in response to programmes. The EU is only planning on issuing large amounts of debt over the next four to five years, but if successful, this approach could be considered longer term. After all this issuance, the EU will become the fifth-largest bond market in Europe behind Germany, France, Italy and Spain.
Providing an Economic Boost
This one deal doesn’t change the global credit landscape too dramatically for investors but does represent an extremely high-quality issuer in a world with few high-quality assets. It should take some pressure off European countries in that they will get economic relief and not need to issue more debt themselves, which is positive. The pandemic has hit Spain and Italy particularly hard, so these and other countries that need support should benefit.
The success of this bond deal shows the EU can easily raise money to help support the economy.
In addition, funds from the €750 billion (US$858 billion) are forthcoming. Individual governments were required to outline what they will spend the money on—which is subject to approval—although some countries have already included the funding in their 2021 budgets. The rescue plan emphasises the greening of the economy, so that ties into the growth in the green bond market as well.
All in all, we think the EU is on the right track in providing relief efforts to stabilise the economy in the wake of the pandemic, and also view these new social bonds as an exciting development for global investors.
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What Are the Risks?
All investments involve risks, including possible loss of principal. The value of investments can go down as well as up, and investors may not get back the full amount invested. Bond prices generally move in the opposite direction of interest rates. Thus, as prices of bonds in an investment portfolio adjust to a rise in interest rates, the value of the portfolio may decline. Investments in foreign securities involve special risks including currency fluctuations, economic instability and political developments.
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1. Sources: Reuters, “Social Bond Issuance Soars on Back of Coronavirus Crisis”, 19 October 2020; Refinitive, “Prospects for Green Bonds and Social Impact Bonds”, 24 June 2020.
2. Source: European Commission press release, 20 October 2020. Basis points are a unit of measurement. One basis point is equal to 0.01%.
3. Source: Ibid.
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