An inaugural social bond by RBS will, it is hoped, support the bank’s commitment to SME lending in areas of high deprivation within the UK, as Edward Russell-Walling reports.

Team 0220

Left to right: James Marriott, Gelan Jamil, Jacob Gilbert, Scott Forrest

Royal Bank of Scotland (RBS) recently issued its inaugural social bond, the first of its kind from a UK bank under the International Capital Market Association's (ICMA's) social bond principles. The bond is linked to the bank's existing lending to small and medium-sized enterprises (SMEs) in some of the UK's most deprived areas.

The €750m holding company senior note issue, in a six-year non-call five-year format, will contribute to the bank's minimum requirements for own funds and eligible liabilities and was more than twice oversubscribed.

The bond reaffirms RBS's commitment to addressing regional inequality in the UK through SME lending in areas suffering from high unemployment and low levels of job creation, the bank says.

Responsible banking

This is part of what RBS describes as "building a more sustainable bank". In September 2019, RBS was one of the founding signatories of the Principles for Responsible Banking, promising to align its business with the UN's Sustainable Development Goals (SDGs) and the Paris Agreement on Climate Change.

Existing responsible banking initiatives include Back Her Business, which aims to help create 65,000 female-led businesses by 2025, as well as Money Sense, a financial education programme for five to 18 year olds, which has helped more than 7.7 million young people to be more financially aware over the past 25 years, and now reaches one in three schools in the UK, according to the bank.

Environmental, social and governance (ESG) goals are increasingly inseparable from finance, according to Caroline Haas, head of sustainable origination, financial institution groups (FIG), at RBS investment banking arm NatWest Markets. "We have pursued a group focus on sustainability," she says. "As the market around green bonds has evolved, we have been thinking about the right route to go down."

Ms Haas points out that while seven of the 17 SDGs are environmentally focused, 10 are social. "RBS wanted to do something different," she says. "You can't separate social and environmental issues, but we felt that the social element of RBS's business was very important."

Made to measure

Impact and compliance are easier to measure on a green bond, Ms Haas observes. "The social bond market has been held back by the difficulty of measurability," she adds. Nonetheless, the group's macroeconomists worked with the treasury department to develop a bespoke methodology to identify eligible SME loans. This enabled RBS to create a robust social bond that could be monitored and reported on annually.

The instrument was the first to be issued under RBS's Green, Social and Sustainability (GSS) Bond Framework, published only days before the bond's launch. The framework identifies 'SME lending' as one of two financing categories that could be linked to social bond issuance – the other is 'access to essential services'.

The GSS framework describes how SME loans align with SDGs – they help economic growth and access to decent work, while creating or safeguarding jobs, revitalising economically depressed areas and reducing poverty.

"The framework allows us to issue green bonds, social bonds and sustainable bonds, which are a mixture of both," says Scott Forrest, head of capital strategy and debt capital markets (DCM) at RBS, the client in this transaction. "However, feedback from investors with whom we engaged was that they had preference for pure green or social bonds, rather than a mixture of the two."

The bank's interest from a treasury perspective is two-fold – competitive cost of funding and alignment with group strategy, according to Mr Forrest. He says that the decision to link the bond to small businesses reflects the fact that RBS banks around one in four UK businesses.

Rich data, poor areas

RBS developed a bespoke methodology to identify appropriate loans for its eligible portfolio, with the help of data from the Office of National Statistics (ONS). To pinpoint areas of relative deprivation, loan level postcode data is used alongside geographical Local Administrative Unit (LAU) classification. Gross value added per capita and unemployment claimant rates in the LAU are then factored in.

Starting with a group SME loan universe of $23bn ($29.9bn), loans have been filtered by loan age, performance, encumbrance and excluded sectors (alcohol, environmental damage, fossil fuels, gambling, tobacco and weapons) to produce a broadly eligible loan pool of £8.6bn. These are ranked into deciles using gross value added and unemployment data, and the bottom 30% constitute the £2.5bn eligible portfolio.

James Marriott, NatWest Markets global head of financial institutions DCM, believes that this approach struck a positive chord with investors. "They liked the use of ONS data to qualify RBS's numbers," he says.

Management of the bond's proceeds will be monitored by a dedicated working group, made up of senior managers across the bank. They will approve any portfolio amendments and undertake a monthly review. Impact reports will be issued at least annually.

A second party opinion has been provided by Sustainalytics, which reviewed the GSS framework and methodology and confirmed their alignment with ICMA principles. It said the bank is "well-positioned to issue green, social and sustainability bonds".

Meeting the investors

On the day that the new bond framework was published, RBS announced a pan-European roadshow contemplating a sterling or euro transaction with an intermediate tenor. It took in London, Paris, Amsterdam, Helsinki and Copenhagen, meeting more than 75 investors on a one-to-one or group basis.

"GSS bonds tend to trade at a premium, but only if the process and framework are fully explained to investors," says Jacob Gilbert, a director in NatWest Markets' FIG syndicate.

While investors were familiar with RBS's credit credentials, the roadshow concentrated on explaining the social bond's structure, the GSS framework and RBS's underlying sustainability strategy. Investor diversification was one of the objects of the exercise and a particular effort was made to engage with sustainability-focused investors who were involved in the GSS market.

The roadshow attracted a number of investors who had not bought RBS holding company bonds in the past. "That helped us to tap into pockets of demand that tend to be sticky, because of the limited supply of social bonds," says Mr Gilbert.

Together with NatWest Markets, joint leads were ABN Amro, Crédit Agricole Corporate and Investment Bank, ING and Nomura. The backdrop for UK issuers was volatile at the time and they chose not to rush the launch of the new bond. "We consciously paused rather than taking the first window," says Mr Marriott. "By bringing the deal a couple of days later we were able to engage certain ESG investors who required more time to evaluate."

Energetic interest

Based on feedback, a euro benchmark six-year non-call five-year social holding company senior deal was announced to the market with initial price thoughts of mid-swaps plus 120 basis points (bps) area.

There was energetic interest from core European jurisdictions, and books reached €2bn by noon of the same day. Spread guidance was revised to 105bps plus or minus 5bps with a suggested issue size of €500m to €750m. Books finally closed at more than €2bn and a €750m transaction was priced at mid-swaps plus 100bps.

At that level, RBS paid no new issue premium, and in fact the bond priced about 2bps inside the issuer's conventional euro holding company senior curve. There were nearly 150 orders in the book and the leads made sure that allocation favoured ESG-focused investors.

The largest pools of demand came from the UK and France, each of which accounted for 27% of the allocation. They were followed by Germany, Austria and Switzerland (a combined 16%), southern Europe (14%), Nordics (7%) and Benelux (6%). By investor type, fund managers took 71%, banks and private banks 14%, insurance and pension funds 9% and central banks 5%.

"The geographical composition was as diverse as for any UK issue for some time," says Mr Gilbert. Some 70% of investors had two of the following three: a dedicated ESG fund, a socially responsible investment (SRI)/ESG policy or an SRI/ESG analyst.

NatWest Markets has begun a programme of 'reverse roadshows' in which it meets investors to quiz them on their ESG strategies and assessment criteria. It plans more such meetings across Europe in 2020.

Given the success of this social bond, RBS hopes to issue more from its GSS framework. "We have tapped into a strong core of demand from investors open to adding the S to their ESG portfolios," says Mr Forrest.


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