On the face of it, the future of sustainability-linked bonds (SLBs) is looking exceedingly bright.
For example, on 7 December, Sustainable Fitch – a specialist division of the rating agency – published research suggesting that, as relevant data becomes more available, capital markets stakeholders are paying increasing attention to the social component of the environmental, social and governance (ESG) agenda.
That interest, says the research, has potential to manifest in several ways – including through the issuance of SLBs with social goals. As such, Sustainable Fitch said: “We expect to see a rising level of issuance of… sustainability-linked debt as investors combine climate and social objectives under single mandates.”
On the same day, Newmont Corporation announced itself as the first-ever mining business to issue an SLB – indeed, as if to align with the Fitch research, the terms of Newmont’s bond require the firm to boost its percentage of female leadership positions.
A few days later, UBS Greater China executive Tasos Zavitsanakis – director of the bank’s local sustainable finance office – told the South China Morning Post that sustainability-linked instruments will form the next phase in the evolution of green fundraising in Asia.
All of which looks hugely encouraging for SLBs. But perhaps it only tells one side of a much more complex story.
On 15 December, Reuters published some research of its own on the current state of SLBs – and found the market’s internal standards wanting.
The news agency notes that, as SLBs are in high demand from investors eager to shine their green credentials, issuers are typically rewarded with lower borrowing costs.
However, its report points out: “[Our] analysis of 48 SLBs issued by the 18 biggest borrowers in 2021 showed that nearly half, or 23, included a target which lets them improve at a slower rate than they have done previously.”
In other words, Reuters says, some of the goals encompassed within these instruments “are so soft that firms can actually take their foot off the gas”.
It explains: “Unlike the bigger green bond market, which funds specific projects, SLBs focus on company-wide targets and do not restrict how the money is spent.”
Responding to the research, Stephen Liberatore – sustainability portfolio manager at financial planning firm Nuveen – wondered: “If the targets and the goals are not aspirational, what are you really getting done?”
The report makes it clear that Liberatore has not purchased any SLBs, “because he does not see them incentivising change”.
In its analysis of specific issuers, Reuters notes that Mexican retailer FEMSA was already 88% of the way towards meeting a long-term goal to boost its use of sustainable electricity before it issued a related, seven-year bond. (Data from a FEMSA spokesperson disputes this, citing a figure of 68% based on absolute consumption.)
One particular area of concern that Reuters highlights is the parallel industry of second-party opinion providers (SPOs): agencies that issuers enlist to evaluate the strength of their SLB goals and commitments.
Hinting at a potential lack of rigor on this side of the equation, the research notes: “Some investors say [that SPOs] are not demanding enough and do their own analysis instead. Opinion providers such as ISS say their job is to give an evaluation, not pass or fail bonds.”
However, regardless of the industry’s defensive stance, this was not the first time that potential weaknesses in the SPO sector fell under the spotlight last year.
In July, Refinitiv outlet International Financing Review (IFR) reported that the SPO industry was in the throes of growing pains, with providers struggling to keep up with the ESG debt market’s rapid expansion.
According to market participants, the SPO capacity challenge could take a long time to resolve as ESG is growing too quickly and unpredictably – even though established finance firms are opening all-new SPO divisions and existing specialists are hurriedly adding staff.
Credit Suisse head of ESG debt capital markets for the Americas Scott Roose told IFR: “SPO providers will tell you that they’re very aggressively hiring, but it’s not turnkey – the bottleneck won’t ease overnight.”
He added: “This is a problem, and it’s probably going to get worse. But we will have to proactively manage upcoming supply.”
Which begs the question: how can investors have total confidence in the integrity of SLBs?
Matt Packer is a freelance business, finance and leadership journalist
