Riding the Green Wave: The Meteoric Rise of Sustainability-Linked Bonds

Riding the Green Wave: The Meteoric Rise of Sustainability-Linked Bonds

Financing the energy transition remains a challenge. However, new financing mechanism have entered the world of finance during recent years. While green bonds seem to be already part of the finance establishment, sustainability-linked-bonds a fairly new – so where are we a few years after their introduction?

The article "Sustainability-linked bonds, the rising star of green finance" discusses the rapid growth of the market for sustainability-linked bonds (SLBs), which hit the $100 billion mark in 2021, just one year after they were first introduced. This growth rate is significantly faster than that of green bonds, which took almost six years to reach the same market size.

SLBs differ from green bonds in that they are tied to the overall environmental performance of a company, rather than financing specific projects. They come with specific targets or key performance indicators (KPIs) related to a company’s loan. If these targets are met, the interest paid on the debt will be lower, incentivizing companies to adopt greener practices.

However, the rapid success of SLBs has also attracted scrutiny from policymakers and the finance community. There are concerns about the risk of greenwashing, as companies are free to decide the indicators they will use as KPIs. This flexibility could lead to targets that are too easy to meet, and there are calls for SLBs to go further than business-as-usual.

To address the risk of greenwashing and organize the market for SLBs, the International Capital Market Association (ICMA) issued guidance and put together a registry of 300 KPIs. It also provided a registry of methodologies for benchmarking SLBs.

In May 2023, the European Leveraged Finance Association (ELFA) in partnership with the International Capital Market Association (ICMA) provided practical recommendations for the high yield market in line with ICMA’s Sustainability-Linked Bond Principles (SLBP), laid down in the guide titled "High Yield Sustainability-Linked Bonds: Practical Recommendations".

It explains that a Sustainability-Linked Bond (SLB) is a performance-based debt instrument designed to encourage the issuer to achieve sustainable outcomes and/or to support the issuer’s contribution to sustainable development. It uses key performance indicators (KPIs) to assess and benchmark impacts and calibrate improvements in its sustainability performance targets (SPTs) by a given date.

Several recommendations for issuers considering issuing a high yield SLB are provided. These include setting a sustainability strategy with all material KPIs identified and related short-, mid-, and long-term trajectories; identifying ambitious SPTs that go beyond business-as-usual; identifying intermediate observation dates to the set SPT(s) when necessary; and aligning key sustainability milestones and the contemplated bond characteristics.

The guide also provides recommendations on process and disclosure, calibration of SPTs, bond characteristics, and reporting. It emphasizes the importance of transparency, meaningful and commensurate variation in the financial and/or structural bond characteristics, and regular reporting of up-to-date information on the performance of the selected KPIs.

The paper concludes with an appendix which includes topics such as the issuer, sustainability-linked notes option, type of bond structural feature, bond structure change, KPI, SPT, SPT trigger, SPT observation date, coupon variation date, optional redemption dates, redemption price with SPTs achieved, redemption prices without SPTs achieved, baseline year, baseline, target year, target performance, long term target, scope/perimeter, rationale, methodology, alignment with Science-Based Target Standards, Second Party Opinion, SLB Framework, and more.