Corporations and ESG (Environmental, Social, Governance) investors have an unprecedented opportunity to unleash a market driven enforcement mechanism of racial and social changes that Americans are demanding. How? Social bonds.
More specifically, KPI (key performance indicator) linked general purpose bonds. These would hold companies to their promises by imposing discounts (or penalties) on the company’s cost of capital should it meet (or fail to meet) management’s promises.
ESG is broadly defined as investments that consider environmental, social and governance factors, and has become the fastest growing market segment within investment management. A broad array of investment styles fit within the ESG umbrella, with the most demanding being those who measure the investment’s impact on society. That is how “green bonds” – financial debt instruments used to fund green initiatives – got a start.
While green bonds have been around for about 10 years, social bonds are relative newcomers to the menu of do-better ESG investments. The International Capital Market Association (ICMA) published Social Bond Principles where they define them as “bonds that raise funds for new and existing projects with positive social outcomes.” While project-based green and social bonds fulfill an important role in sustainability, they are limited in power to implement sweeping changes.
The American people have made it clear that gross racial inequities will no longer be tolerated. Corporations have reacted with half a billion in donations and scattershot promises. Netflix launched a new BLM category, Amazon pulled its facial recognition technology from police departments (for a year), and Adidas publicly committed to making 30% of all new hires African-American or Latinx minorities. The problem is these initiatives lack teeth. A year from now, once protests quiet down, it may all go back to “normal.” Amazon seems to be betting on it.
Absent an enforcement mechanism, we are left with not much other than hope. Congress is responding with changes to policing, but the prospect of any regulatory changes to the way firms hire and promote their workforce (which is what really matters) would be anathema to business.
If corporations are truly committed to their promises, they should issue KPI linked general purpose bonds to prove it. ESG investors should demand them.
To be sure, this is a very new concept. The notion of a KPI-linked general purpose (green or social) bond was unheard of until ENEL, the Italian utility company, issued the first of its kind in October of last year. It was innovative because the bond was not issued to fund XYZ project, as most green/social bonds do. Rather, it generated KPI’s that held management accountable by attaching financial penalties (coupon step ups) for failing to meet them.
Not all investors liked ENEL’s sustainable bond innovation. Some complained that the KPI’s were already part of the company’s broader strategy, meaning it did nothing to generate further impact. Others noted that a carrot driven mechanism would be better suited for real change.
No doubt there are a variety of needs, but this mechanism would satisfy the market-driven American mentality, as well as the desire for enforcement of corporate promises. In addition, companies may further broaden their investor base by fulfilling requirements of the most discerning ESG mandates, namely impact investments.
Impact investors expect not only a financial return, but also demand a positive impact to society. They are typically well suited to private investments due to reporting and transparency requirements. Calculating the impact of a project-level investment requires a high level of transparency, which is often difficult to do. A KPI-linked general purpose bond is different. It could satisfy transparency demands of impact investors because the key performance indicators would be at the company level. This means the data would be simple to track and the impact easier to measure. (Remember the Adidas promise to make 30% of its new hires Black or Latinx?)
Broad use of KPI’s directed at social disparities would help move the country toward greater racial equity. A journey that, according to a study by the Kellogg Foundation, could yield an additional 0.5% of economic growth, per year.
The prospect of broad implementation is not only exciting from a market innovation perspective – 20 years ago when I started out, this would have been fantasy – but also for my own biracial children for whom I hope the future will be much brighter.