When it comes to environmental, social, and governance (ESG) practices, the “S” has long been viewed as the more complicated piece of the conversation for most investors.
But that perspective has begun to change in recent years. The disproportionate impact of the pandemic and our U.S. racial reckoning have laid bare the structural inequalities that limit access to opportunity. That recognition has catapulted social finance to the forefront of the sustainable debt market, growing from $20 billion in 2019 to a record $199 billion in 2021, and it has spurred issuers to offer products that explicitly support racial and gender equity alongside other socioeconomic goals.
Though there is skepticism about whether some corporate commitments to racial equity investments will be fully realized, we think the heightened interest in “S” will continue.
In part, this is because the underlying idea of what constitutes “social” in ESG seems to have shifted. Traditionally, it has referred to how a company deals with social trends, labor, and politics in order to increase profits and boost corporate responsibility. Now, more investors are actively pursuing opportunities to support justice, equity and inclusion, directing capital to projects and initiatives that respond to community needs.
Mission-driven lenders and intermediaries are both contributing to and reflecting this expanded investor appetite. In the U.S., community development financial institutions (CDFIs) and other nonprofit lenders are seeking to democratize social investing with fixed income products that are non-extractive for communities and offer low initial entry points, so more investors can participate.
Social bonds are not new, of course, spanning a diversity of issuers and investors. But the explicit use of proceeds to support racial equity is a more recent evolution. In fact, we have seen a number of corporations and foundations issue social bonds and use the proceeds to lend to CDFIs, which in turn invest to dismantle racial disparities.
That activity may dissipate as more organizations return to pre-pandemic strategies and interest rates rise. But we think expanded CDFI issuance is a sustainable trend. The growth of the social bond market has offered a unique opportunity for nonprofit issuers to communicate with retail and institutional investors that are unfamiliar with the sector. Through alignment with widely accepted yardsticks, like the International Capital Market Association’s Green, Social and Sustainability Bond Principles and UN Sustainable Development Goals, they have been able to better articulate how and why they raise debt to fund high-impact plans.
For example, our organization, the Local Initiatives Support Corporation (LISC), is a CDFI that has issued debt alongside other financing tools to support our work, including our Project 10X initiative, which is focused on addressing racial gaps in health, wealth and opportunity throughout the country. In addition to obtaining public credit ratings, we have increasingly aligned our efforts with Social Bond Principles (SBPs) and connected our goals to the SDGs, all of which makes it easier for investors to understand the field of community development finance, where CDFIs have been active for decades.
LISC has certainly not been alone in bringing new products, strategies and investors to racial equity efforts. Last summer, US Bank and Enterprise Community Partners issued the market’s first racial equity bond to provide targeted investments to underserved communities of color. And last month, the Public Finance Initiative (PFI) and the National League of Cities (NLC) launched a new effort to help issuers center racial equity and measure how social determinants of equity change over time. The collaboration is focused on the municipal bond market, but it should add value for other issuers, investors and stakeholders as well.
Finally, we are also seeing nonprofit issuers look to impact measurement and management rubrics like the Impact Management Project, Impact Frontiers and the Operating Principles for Impact Management to help tell their story. Those practices make it easier for investors to assess financial and impact performance, while at the same time prioritizing the voices of local stakeholders.
These types of analytics can also help identify unintended consequences for both issuers and investors. For example, some credit-based lending programs may include racially biased investment terms in their programs, often without recognizing them as such. By better understanding how and where this occurs, nonprofit lenders can both leverage philanthropic or subordinated capital to mitigate credit risks and educate partners on the ways that discrimination has infiltrated the American financial system. This education process is part of broader systems change.
What does all of this mean for the future? We may begin to see a sustainability-linked market develop specifically around social themes. Issuers might specify a percentage of financing for an underrepresented population or target a number of affordable housing units for individuals facing homelessness. By connecting social outcomes and financial performance, there are fewer opportunities for “social washing.” If you can measure it, it is harder to fake.
We think these indicators add up to a lasting shift in the pursuit of the “S.” Mission-driven issuers will continue to offer tools that drive capital into justice-focused work. And, in the process, they will offer investors more opportunities to live up to their stated values, not just within their companies, but in the communities where they live and work as well.
Annie Donovan is executive vice president and chief operating officer of the Local Initiatives Support Corporation (LISC). Anna Smukowski is LISC’s senior director of investor relations and capital strategies.