How Capital Markets Can Contain the Coronavirus

As governments and central banks run out of fiscal stimulus options, COVID-19 social bonds could be critical in softening the economic blow.

A woman wearing a face mask sits at a bus stop in Paris on April 21.
A woman wearing a face mask sits at a bus stop in Paris on April 21. CHRISTOPHE ARCHAMBAULT/AFP via Getty Images

Governments and central banks around the world are exhausting their policy toolkits to address the economic repercussions of the coronavirus pandemic, but monetary and fiscal stimulus alone may be insufficient to deal with the crisis. On April 14, the International Monetary Fund warned that global lockdowns would produce “the worst recession since the Great Depression.” Interest rates in the United States, the European Union, the United Kingdom, and Japan are already near zero, and sovereign debt is set to spike from hefty stimulus packages. Other funding solutions are needed to reduce COVID-19 infections, to deliver a vaccine, and to keep businesses running.

That’s where capital markets can help. Social bonds in particular have emerged as a way to mobilize private capital for the public good. Like conventional bonds, social bonds offer fixed returns for investors but use proceeds exclusively for social causes—similar to green bonds that concentrate on the environment. As fears rise around the world of dwindling central bank ammunition and ballooning debt-to-GDP ratios, social bonds are poised to play a crucial role in the fight against the coronavirus and its effects.

Social bonds are essential to containing the economic fallout of COVID-19 and building resilience against future shocks. Their proceeds could waive health insurance costs, subsidize pharmaceuticals, and support small businesses to prevent insolvencies. In developing countries with limited fiscal firepower to keep essential industries afloat, social bonds would be especially critical. And unlike ordinary bonds, social bonds disclose exactly how their proceeds are used—an attractive prospect for institutional and millennial investors who want to know how their money is used.

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The social bond market has traditionally been stymied by low liquidity levels, with global issuances totaling $13 billion last year—versus $257 billion for green bonds, according to the global research firm Sustainalytics. Despite their value, social bonds fill a niche: addressing socioeconomic issues that other capital market mechanisms do not. COVID-19 social bonds are generating significant investor interest, paving the way for more issuances. Governments around the world have already lowered interest rates near zero and doled out massive stimulus packages. The stage is now set for social bonds to move from a niche solution to a mainstream one.

The first COVID-19 social bond, and the only one so far from a corporate bank, was issued by the Macao branch of Bank of China in late February. The lender raised more than $600 million from its COVID-19 Impact Alleviation bond to support Macao’s small and medium enterprises. The Chinese government has already announced a slew of fiscal and monetary actions to provide relief to and spur lending for small companies—but as in other countries, rising debt levels constrain the extent of this assistance.

The World Bank’s International Finance Corporation (IFC) has since March raised $1 billion from a social bond—its largest to date—that will boost production of medical supplies in emerging markets. The IFC has also pledged $8 billion to existing clients in sectors directly affected by the pandemic, such as tourism and manufacturing. In many developed countries, these industries are receiving accessible loans and grants from the government, but economists warn that the current measures—including the United States’ $2 trillion relief fund—simply aren’t enough to cover the long-term damage of the pandemic.

The African Development Bank in March sold its Fight COVID-19 Social Bond for $3 billion, which it claimed was the largest-ever dollar-denominated social bond in international capital markets. That sum will go toward essential infrastructure in Africa, such as water and food security—areas considered at risk as African countries face the effects of lockdown, declining tourism, and lower commodity prices, Emeka Anuforo, the bank’s communication officer, told Foreign Policy.

In the European Union, the Council of Europe Development Bank, the Nordic Investment Bank, and Italy’s Cassa Depositi e Prestiti bank have each announced COVID-19 social bonds focused on health care and direct lending for small businesses. As it becomes clear that more funding is needed for economic recovery than even the strongest national efforts can provide, investors have a key role to play. “These social bonds could be both an early signal and a catalyst that will enable private investors to play a meaningful role in the pandemic recovery,” said Robert de Jongh, a specialist leader of social finance at Deloitte.

The International Finance Facility for Immunisation (IFFIm) is credited with producing the world’s first social bond in 2006, which increased the availability of vaccines for illnesses such as yellow fever and polio in developing countries. The organization is considering a new bond to fund global research and deployment of a coronavirus vaccine, IFFIm board chair Cyrus Ardalan told Foreign Policy.

Low levels of corporate issuances have had limited growth in the social bond market for years, but the coronavirus could change that. Governments, multilateral organizations, and financial institutions typically account for the majority of issuers. But for the sector to flourish, companies must participate so overall liquidity can increase. Denise Odaro, the IFC’s head of investor relations, said on a recent podcast that the problem lies with the nature of social issues: Green bonds have benefited from the momentum around climate change, while investors view social causes more subjectively.

The COVID-19 response is a social cause that all market players can agree on.

But the COVID-19 response is a social cause that all market players can agree on, Odaro said. Just as green bonds have fast-tracked reductions in global carbon emissions through the financing of reforestation and renewable energy projects, social bonds can speed up the pace of economic recovery by industries affected by the pandemic and maintaining basic services.

While innovative finance has the potential to be leveraged across different economies, monitoring the scope of its impact is critical.

Until investors have a clear framework for measuring outcomes, they are likely to remain cautious. The IFC recommends that social bond issuers examine impact through qualitative indicators such as the number of jobs saved or availability of COVID-19 tests. But that’s hard to do in crisis situations, said Gayle Peterson, a specialist in social investing at the University of Oxford. “Coming up with targets for this pandemic can be difficult when you don’t have enough masks or ventilators for immediate use.”

Durreen Shahnaz, the CEO and founder of the Singapore-based Impact Investment Exchange, highlighted the importance for social bonds to include the perspective of their beneficiaries. For example, the bulk of COVID-19 responses across countries “have been carried out without an eye to its impact on the world’s most vulnerable community—women,” she said. “Yet women are bearing the brunt of the pandemic due to their outsized role at the front lines of health care delivery and at the backbone of their families.”

Furthermore, complications arise when issuers mix social causes into other bonds. Since February, scores of Chinese companies have sold so-called “virus control bonds” that commit a minimum of 10 percent of their proceeds to epidemic control efforts. But many experts worry that the funds are actually helping issuers avoid default—a concern that is beginning to extend globally as the ratings agency S&P warns of a 10 percent spike in U.S. corporate default rates over the next year.

The months ahead will likely see a wider range of sustainable financial initiatives dedicated to the COVID-19 response, including impact investment funds and pay-for-success (PFS) models. In PFS models, investors are paid out by a third party only if agreed-on outcomes are achieved—making them far riskier than social bonds. It’s unclear how appropriate PFS programs are for the current crisis since they need a clearly defined results metric that can be measured over the bond’s lifetime.

The coronavirus outbreak will likely motivate more governments, companies, and international bodies to lean toward social financing. The Spanish bank BBVA estimates that global issuances of green, social, and sustainability bonds will reach $320 billion in 2020—a year over year increase of 28 percent—and the pandemic is set to accelerate that pace. In the span of a year, the Council of Europe Development Bank preserved more than 40,000 jobs through a social bond it launched in April 2019. If private investors buy in, the same could happen with the current tranche of coronavirus bonds—giving capital markets a crucial role in recovery from the pandemic.

Nyshka Chandran is a freelance journalist covering geopolitics, society, and culture across Asia. Twitter: @nyshkac