The coming of age for Sustainability-linked Bonds (SLBs)
The sustainable bond market is growing quickly, exceeding $1 trillion in issuance and total volume last year (source: Bloomberg New Energy Finance), as investors increasingly look to align their financial goals with international sustainability benchmarks such as the Paris Agreement and UN Sustainable Development Goals (SDGs).
Unlike traditional green, social, or sustainability use-of-proceeds bonds, which fund specific projects dedicated to environmental or social utility, sustainability-linked bonds (SLBs) typically are not directly linked to the financing of particular projects. Instead, they fund the operations of issuers that explicitly link sustainability objectives across their business with financing conditions. For example, if an issuer fails to meet its firmwide greenhouse gas emissions reduction target, the coupons on its SLBs would step up to a higher level.
The SLB market has grown significantly since the International Capital Market Association (ICMA) released its Sustainability-Linked Bond Principles in June 2020, a set of voluntary guidelines aimed at improving the transparency and overall integrity of the SLB market.
Total issuance of sustainable bonds across all sectors and asset classes rose nearly tenfold in 2021 to $108.3 billion, and increased a further 15% year over year in the first half of 2022 to $54.2 billion, according to Bloomberg New Energy Finance.
Figure 1 — Total ESG Bond market issuance (USD Billions)
Benefits of sustainability-linked bonds
Sustainability-linked bonds may motivate businesses to improve their sustainability performance, which for environmentally sensitive sectors typically means reducing greenhouse gas emissions and other externalities. They may also:
- Motivate issuers to set targets aligned with global benchmarks, in particular the Paris Agreement on climate change and the UN SDGs.
- Enable more issuers to access ESG-labeled bond markets, including those with lower direct capital expenditures that would qualify as green expenses.
- Allow investors to diversify across geography, bond maturity, industry, or bond rating.
As you can see from the chart above, the top five SLB sectors include:
- Utilities
- Retail
- Consumer Goods
- Business Services
- Paper and Packaging
Transparency is the key to SLBs
While the ICMA’s guiding principles have improved the SLB market’s credibility by encouraging more transparent disclosure and reporting, there is still room for improvement given that a number of debatable practices continue to pose challenges for investors. These include bond structures perceived as misrepresenting the positive environmental impact of SLBs or issuers’ degree of commitment to advancing sustainability issues, a practice that may be associated with “greenwashing.”
Such practices may overshadow examples of quality SLBs and sustainability targets. For example, in many cases, deals have included ESG metrics only for direct greenhouse gas emissions even if the vast majority of the issuer’s overall emissions are indirect and other sustainability metrics, such as water, pollution, waste, safety, or health, are more relevant for the issuer’s industry.
This year, the ICMA updated the illustrative KPI registry and the Q&A related to SLBs, which complement the Sustainability-Linked Bond Principles, to clarify in particular the key performance indicators (KPIs, the credibility of the targets, coupon step-up, and structures that SLB issuers should use).
Takeaways
After a jittery 2022 for ESG bond markets, Sustainability-Linked Bonds are at the forefront of Companies debt considerations as the methodology provides flexibility for Companies to meet their internal KPIs in a more flexible way linking the KPIs at Board level to their debt packaging.
At Gallantree, we are busy setting up our ESG Bond programs and have a number of companies interested to issue. Come and see us today about your ESG Bond issuance requirements.
