Scotia’s $22.93 million sustainability bonds on Stoxx Global Select may draw ESG investors

By Emma Trincal

New York, Jan. 5 – Bank of Nova Scotia’s $22.93 million of 0% market-linked step-up notes due Dec. 30, 2024 linked to the Stoxx Global Select Dividend 100 index illustrates sellsiders’ growing motivation to tap into the popularity of ESG investing. ESG stands for Environmental, Social, and (Corporate) Governance.

While the notes do not offer exposure to an ESG underlying, the securities will be issued as sustainability bonds, according to a 424B2 filing with the Securities and Exchange Commission.

That’s because Scotia intends to use the proceeds for financing or refinancing businesses or projects that meet eligibility criteria under the bank’s sustainable bond framework established in July, according to the filing.

“It gives you, the investor, an opportunity to make a difference. A lot of issuers want to get on the bandwagon. Socially responsible investing is a huge market. ESG sounds good. Everybody wants to do good. Good energy, good governance.” an industry source said.

Global ESG assets are on track to exceed $53 trillion by 2025, according to Bloomberg.

Proceeds with a purpose

Bank of Nova Scotia’s recent offering is not an isolated case.

In September, Barclays announced the launch of its inaugural Green Structured Notes Program. Under this platform, the proceeds of structured notes are allocated to the financing or refinancing of eligible green activities such as renewable energy, energy efficiency and sustainable transportation loans, according to a company’s press release.

Step-up

Scotia’s notes offer a straightforward structure. If the index finishes above the step-up value, 145.55% of the initial value, the payout at maturity will be the index return.

If it’s at or below the step-up value but at or above the initial value, the payout will be par plus the step-up payment of 45.55%.

Investors will be fully exposed to any index decline.

“45% on the upside, 100% on the downside. I don’t like this at all,” the industry source said.

A buysider said he would also prefer to see a barrier or buffer over three years.

“There may be some people who would like something like that. But you’re not getting the high-yielding dividends of the index.

“I think they use the socially responsible thing as a selling point. It’s like a hook. It’s such a hot market. Who doesn’t want to save the world?”

No ESG exposure

Rather than the structure, the interesting aspect of the notes was the use of the proceeds, said a market participant.

“It seems very similar to those green bonds. Normally, issuers state in the documents that the proceeds will be used for general corporate purposes. Here, it goes to green industries and companies. It’s a selling point obviously,” he said.

The prospectus disclosed some of the risks and limitations involved with the way proceeds will be invested.

First, the notes may not be suitable for investors with a mandate to invest in green or social assets, since the Stoxx Global Select Dividend 100 index “is not a so-called ESG index, nor is it intended to be,” the filing said.

While the use of the proceeds may be an incentive for investors to purchase the notes, there could be conflicts of interest if some of the underlying index components of the Stoxx index do not meet ESG criteria. Such conflict would be evident for instance if some of the index constituents were the stocks of companies selling tobacco and weapons.

The issuer, as a result, warned investors not to make investment decisions based on the use of the proceeds but rather on the underlying index.

The Stoxx Global Select Dividend 100 index combines the highest-yielding stocks from the Americas, Europe and Asia/Pacific regions, with 40 components for the Americas and 30 components each for Europe and Asia/Pacific.

“The investment of the proceeds by the issuer has nothing to do with how investors make money. They make money based on the performance of the underlying index,” the market participant said.

Discretion, no obligation

The issuer also disclosed its sole discretion in picking the social and green assets in which it intends to reinvest the proceeds.

“You can either buy a note linked to a sustainable index, for instance the S&P 500 ESG index. In this case you get direct exposure to this asset class. Or you do it with this kind of green bond. Some people have a stronger urge to support environmental or social causes. They want their money invested directly. In that case, the use of proceeds is an incentive, but it has nothing to do with how you will generate your return,” the market participant said.

There is however a caveat. In a hypothetical scenario, the issuer’s allocation decisions may affect the value of the bonds, according to the prospectus.

The filing states that the issuer has the intention but not the contractual obligation to allocate the proceeds to green and social assets. Failure to do so does not constitute a credit event and cannot give rise to a claim by noteholders, according to the filing. Yet it may have an impact on the investment itself.

“Any such failure may affect the value of the notes and/or have adverse consequences for certain investors with portfolio mandates to invest in green or social assets,” according to the filing.

The market participant argued that the situation would be unusual.

“If they did not allocate, you could in theory be in a situation in which some investors may dump the bonds,” he said.

Reporting

If the issuer allocates the proceeds as it intends to do, investors may not get detailed reports on the selected investments, according to the prospectus. Scotia will use the methodology it created in its Scotiabank Sustainable Bond Framework, which lists lines of green and social business and eligibility criteria. But the reporting disclosure of the prospectus stated annual updates regarding the net proceeds raised from the notes and the aggregate amounts of funds allocated to finance or refinance each of the eligible categories.

For the market participant, the level of transparency was satisfying given that returns are tied to the index, not to the proceeds.

“The filing is disclosing all the possibilities to people, which is good. You want to do that,” he said.

“There’s nothing that unusual here except that the issuer intends to use the proceeds for a particular purpose. As required by the SEC, they have to disclose the purpose in the offering document and that’s what they did.”

BofA Securities, Inc. is the underwriter.

The notes settled on Monday.

The Cusip number is 06417X515.

The fee is 2.25%.

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