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THE RETURN OF SUSTAINABILITY-LINKED BONDS AFTER A DISSAPOINTING 2022


Sustainable debt suffered a setback last year. While some point to that being a sign of things to come, others are more optimistic. Andrew Holt reports.


Debate surrounds the prospects of the sustainability-linked bond (SLB) market after 2022 proved to be a difficult year. Sceptics say SLBs face growth obstacles, citing last year’s decline in issuance as evidence, resulting in the asset class being at an ‘inflection point’, according to Dennis Sugrue, global insurance ESG lead at S&P Global Ratings. Another point is that unlike green and social bonds, there are no restrictions on how those issuing SLBs can use the pro- ceeds. Instead, the coupon is linked to the sustainable perfor- mance of the issuer.


This is typically done through a ‘step-up’ mechanism whereby the issuer pays a higher coupon if it does not achieve pre-defined targets. Such an approach ‘should not be allowed or encour- aged,’ according to the European Banking Authority. And like the growing field of green-related investments, allega- tions of greenwashing are not far away. SLBs have ‘lost their mojo’ due to greenwashing accusations and concerns over legal repercussions from including sustainable key perfor- mance indicators in their bond documentation, according to an assessment of the market by Barclays.


The lack of a premium on SLBs also makes them less attrac- tive, Barclays added. Yet despite this, Moody’s said in a report that it expects about $75bn (£60bn) worth of SLBs to be issued globally in 2023, an uptick from last year’s decline, where $70.4bn (£57bn) was raised. Context should be noted here: one in which 2022 was tough in the debt markets overall. Jo Richardson, head of portfolio strategy at the Anthropocene Fixed Income Institute, said any criticism of SLBs is mis- placed. “They improve disclosure from issues and elevate sus- tainability into a key part of investor dialogue. This improves regulatory disclosure around sustainable performance.” She added that such debt products could introduce real change. “SLBs have the potential to be a transformational product; uniquely suited to raising capital to transition businesses in hard-to-abate sectors,” she said. On the decline of SLBs last year, Richardson added: “Volumes of SLBs decreased in 2022, alongside volatile market condi- tions. Growth is recovering, alongside positive market senti- ment for the complementary role of this product alongside other sustainable debt instruments.”


She said that SLB issuance is more focused amongst corporate entities, often high yield or unrated. “Investor demand appears


to be strong, incorporating sustainability commitments into these debt products,” she added.


Bank on the SLB


Other areas of growth in the adoption of SLBs that have been cited are among banks and sovereigns, looking to embrace the asset class as they seek to reinforce their sustainability commitments.


Chile was the first sovereign to issue an SLB in March 2022, selling $2bn (£1.6bn) worth of 20-year paper. Uruguay fol- lowed in October.


The simplicity and flexibility of SLBs could appeal to more emerging market sovereigns that may find it difficult to meet the reporting requirements for use-of-proceeds bonds, Sugrue said. A point highlighted by a World Bank survey of 28 emerg- ing market sovereigns last year, where six said they were con- sidering sustainability-linked bonds.


The growth of SLBs has fed across different sectors. Italian energy group Enel issued the first such debt in September 2019, agreeing to pay 15-basis points more if it missed its renewable energy target. Then rapid growth was predicted for the SLB market as the instrument would allow a broader uni- verse of issuers to obtain sustainable financing due to the flexibil- ity in how funds are spent. And while this played out, with global SLB issuance growing 10-fold in 2021 to $94.38bn (£76bn), activity tailed off in 2022 to $70.4bn (£57bn), according to S&P Global Ratings. In the financial space, mortgage lender Berlin Hyp became the first bank to issue an SLB in 2021. It allowed the bank to share its decarbonisation plans and progress with market partici- pants and show its commitment to reaching its target, said Bodo Winkler-Viti, head of funding and investor relations.


Taking a holistic view


Another advantage of an SLB is that it takes a ‘more holistic approach’ because it relates to the whole organisation and not a single portfolio, Winkler-Viti added.


In addition, the short period of time SLBs have been around has to be considered when assessing them and their develop- ment, Richardson said. “The products have only been around for three-and-a-half years. If you look at how long it took green bonds to grow, it took longer.”


Richardson concluded that SLBs should be a strong considera- tion for investor portfolios. “They are a powerful product. Ele- vating sustainability into the dialogue. All investors should be thinking about them, especially for fixed income. “Investors should be thinking about the sustainability of their own portfolios and sustainability bonds enable you to have vis- ibility over these plans. Sustainability bonds can act as a good hedge. They are a powerful complementary product.”


Issue 124 June 2023 | portfolio institutional | 33


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