Who pays for sustainability? The first empirical study of sustainability-linked bonds.

As companies worldwide pledge to net-zero emissions and more sustainable activities to contribute to a low carbon economy, a fundamental question arises: Who pays for this shift to sustainability?

In a recent by the and the of the University of Zurich, researchers Dr. and explore the novel phenomenon of sustainability-linked bonds (SLBs), which are bonds with a coupon linked to the issuer achieving a sustainability target.

From the perspective of impact investing, SLBs are an important and promising mechanism. But it’s often unclear who pays for the sustainability improvement in the case of SLBs. To investigate that, the researchers examined over 100 bond pairs covering USD 49 billion in notional amounts, which equals one-third of the entire SLB market.

If the investor pays for the improvement in sustainability, then SLBs are a mechanism for investors to have impact. According to the findings of their paper “,” posted on January 12th, 2022 on the Social Science Research Network’s eLibrary, for the majority of SLBs (65 out of 102), investors pay the issuing company for the improvement in sustainability, with the company earning a sustainability premium. On average, the study shows a sustainability premium of 29 basis points, meaning that issuing companies receive this as a discount from investors when issuing an SLB, even before reaching a target. Their analysis suggests that the sustainability premium is larger for bonds with a higher coupon step-up and callable bonds.

While in most SLBs, the investor pays for this improvement, there are also companies (35 out of 102) that do not benefit from a sustainability premium. Potentially, these companies pay out of their pocket to issue SLBs to signal their commitment to sustainability.

“SLBs are a promising instrument for sustainable finance, but they are also complex. It’s important they are designed properly to incentivize companies to improve their sustainability performance and not allow SLBs to be used for greenwashing,” says Dr. Kölbel, co-author of this paper.

Indeed, the scientists showed a ‘free lunch’ for many SLB issuers (55 out of 102), as they benefit financially from the SLB even if they fail their sustainability target. This could incentivize greenwashing, as SLBs could be issued purely for financial reasons without a commitment to sustainability improvements. The incentive for greenwashing is particularly strong when the bond is callable, as this allows issuers to reduce the penalty they have to pay in case they fail their target.

To have an impact, the study suggests that SLBs should have ambitious sustainability targets, and there should be a penalty for issuers when they fail on the target. Also, SLBs should not be callable, as this makes it unclear whether the company is truly committed to the target. Nevertheless, “the ‘free lunch’ is most likely an indication of strong investor demand for SLBs,” says Lambillon, co-author of this paper.

Read our full paper here:

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