Sustainability is the hot topic in financial markets
Yet, there is still some confusion about the various instruments corporates, financial institutions and sovereigns use to fund their activities. Originally, sustainability bonds, green bonds and social bonds were mostly issued by development banks like the European Investment Bank. Later on, commercial banks financing wind farms or social housing also came up with green bonds or social bonds respectively. Whereas those instruments are solely defined by their purpose there is another funding option becoming increasingly popular: sustainability-linked bonds. There is no legal definition for sustainability-linked bonds, but there is a widely accepted market standard by ICMA which is called Sustainability-Linked Bonds Principles.Five things you need to know:
1. Sustainability-linked bonds’ proceeds can be used for general financing needs, e.g., construction of factories, personnel expenses, M&A and many more.
2. Like with any other bond the issuance is performed by banks and the documentation defines the bond: term, call rights, notice period, coupon and so on. The coupon is tied to predefined sustainability performance targets (SPT) and KPIs the issuer commits to. This means, the issuer will pay an extra premium to the bond holders, if he doesn’t achieve his sustainability goals by the time defined.
3. Most often SPTs contain reduction of GHG emission, water efficient production, equal-pay policies, diversity goals or charity activities. Basically, the SPTs and related KPIs can contain everything related to ESG, but they should make a fundamental and ambitious contribution to the business model and the sector. It is recommended to seek for external review of the selection of KPIs and calibration of SPTs to ensure and show that the goals set are not mere greenwashing.
4. Reporting and verification are key for sustainability-linked bonds. The issuer should report on his performance at least once a year and must provide external verification of his performance level against each SPT for each KPI by a qualified external reviewer such as auditors or environmental consultants. Unlike external review for the bond program external verification of the sustainability performance is obligatory.
5. Sustainability-linked bonds are the fastest growing segment of the sustainable finance market, with a total issuance of USD 93 billion in 2021 - coming from USD 8.8 billion in 2020. Generally, issuers come from very different sectors like fashion (Chanel), retail (Tesco), construction (ASTM) and energy infrastructure (Enel). In 2021 Teva was the first pharmaceutical company to issue a sustainability-linked bond. Teva raised USD 5 billion making it the biggest sustainability-linked bond ever issued.
Sustainability-linked bond issuances are costly and can increase reputational risk in case the issuer doesn’t meet its SPTs. Thus, they are only suitable for public companies that have an effective ESG management in place. Sustainability-linked loans are a comparable instrument for private companies seeking to foster the relationship with their lenders and to improve their ESG profile. Before starting talks with the lender, the company should be aware of its ESG management capacities (staff, IT, reporting process etc.) and its ability to reach ambitious targets in the short and midterm. Can you reduce GHG emissions in production? Can you enforce human rights in the supply chain? Can you appoint more women to the board to improve gender equality?
By the way, BECEPTUM offers ESG maturity assessments. We are happy to answer your questions!
