The Covid-19 fightback funding gap is the size of The Big Hole - a sovereign social bond could help

Impact investing, which seeks a social and environmental impact alongside positive financial returns, is no longer sniffed at by hard-bitten investment managers as a hobby product created for bunny huggers. 

It is now a mainstream asset class with over $500-billion in assets under management – and growing. 

However, it’s only more recently that governments have come to recognise that they too can leverage the growing investor appetite for products that “do good” while delivering an acceptable financial return. 

It is on the back of this trend that research house Intellidex, backed by the economists collectively known as the Covid-19 Economists Group, has developed the concept of a social bond that can be used to fund the fight against Covid-19.

Intellidex is proposing the issue of three distinct bonds, possibly with different yields, under the banner of the Covid-19 sovereign social bond: domestic institutional, domestic retail, and offshore institutional.

It is notable that Intellidex includes the retail investor, you and I, in the proposal.

“Over 170,000 individuals and entities in South Africa made donations to the Solidarity Fund, indicating the degree of public support for the fight against the crisis,” says Stuart Theobald, chairman of Intellidex.

“We believe there is potentially a meaningful amount that can be raised from the public, including corporations. The aim should be to unite South African and international investors in a joint effort to finance the battle against the disease in the country, much like the War Bonds.” 

It’s a novel idea that should be considered.

Finance Minister Tito Mboweni is scheduled to present an amended Budget to the country on 24 June, and what is clear is that South Africa faces a significant funding shortfall.

The government’s R500-billion Covid-19 economic package, announced on April 21, includes several elements that will have to be funded out of the Budget. However, rejigging the Budget will not be easy considering the SA Revenue Service has already said that revenues this year could be R285-billion less than projected in February. 

In addition, state-owned entities are falling like flies and will require more funding than was anticipated in February.

The size of the hole is not yet clear. Intellidex estimates a Budget deficit of 15.4% of GDP, which assumes a contraction in growth of 10.6% and translates into a total funding requirement of R806.7-billion. 

Under a more negative contraction of 15%, the deficit could be 17.5% of GDP and a funding requirement of R863.3-billion.  

To put it into context, before the crisis, the Budget deficit was projected to be 6.8% this year.  

Government has been funding its deficit through weekly bond issuances and plans to step up the amounts raised in these auctions by about 36%, says Theobald. 

The problem is that there is a limit to the amount that local banks and institutions can absorb. 

Additional funding will come in the form of soft, unconditional loans from multilateral organisations such as the New Development Bank and the International Monetary Fund.

But this won’t be enough. 

“Even with these sources available, we foresee significant additional funding needs,” he says.

A social bond could be attractive to investors. “Increasingly we are seeing investors allocating a specific portfolio tranche to ESG themes.”

The mechanisms for these investments vary widely, but Intellidex believes the South African government could become one of a few sovereigns to issue a social bond to fund its battle against the Covid-19 crisis – not just right now, but further into the future.  

The success of the issuance depends on several factors, one of which is providing investors with certainty that their “impact” mandate is being achieved. In other words, they do not want the funds raised to disappear into the black hole of the fiscus. 

“These instruments are subject to targets and governance frameworks like any other investment,” says Theobald. “The targets may be voluntary, but market acceptance will be substantially greater if the bond can demonstrate that it complies with these, such that investors can be confident it meets their mandates and objectives.”

It is proposed that the domestic Covid-19 sovereign social bond uses the same mechanism and documentation as the weekly bond auctions. In addition, Intellidex is proposing the use of a “step-up” coupon structure which would serve as an incentive to government to use the money for the mandated social purpose. 

This would take the form of a dual coupon with a standard amount paid to bondholders, but with an additional spread paid on top of the coupon should the government fail to deliver on the social objectives set out for the bond. 

“The step-up forms a financial penalty to the government should it simply use the proceeds of the bond as part of general government expenditure instead of the Covid-19 crisis,” Theobald explains.

This is not unheard of in the South African context. The World Bank Eskom Renewables Support Project has a carbon offset requirement with a battery project and wind farm. Should the offsets not be achieved, a step-up interest payment becomes due.

This structure is not envisaged for the international bonds, which could be listed on the Luxembourg Stock Exchange, which is where the government’s USD-denominated Eurobonds are listed.

The idea of a social bond is not a pie-in-the-sky scheme. There are domestic and international precedents.

Locally, several green bonds have been issued, including two by cities – City of Johannesburg and City of Cape Town. 

In addition, two social impact bonds have been issued, which differ slightly from social bonds in that they provide a return to investors only if the social objectives are achieved. 

This is unlike social bonds which provide the agreed return regardless.

The first was an early childhood development SIB launched by NGOs mothers2mothers, Volta Capital and the UCT GSB Bertha Centre for Social Innovation and Entrepreneurship. 

The second was a job creation bond called Bonds4Jobs arranged by Harambee Youth Accelerator with R75-million invested upfront. 

Since the outbreak of Covid-19 just one country, Guatemala has issued a social bond to be used to fight the impact of the virus. The bonds, worth $1.2-billion, are listed on the Luxembourg Stock Exchange with a prospectus that lists eligible social investments, including health, food security, education and the provision of basic infrastructure. 

The South African government has long commanded global respect for its bond issuance and financial transparency. “This positions it well to become a pioneer in sovereign social bond issuance,” says Theobald. DM/BM