Industry insiders Mitu and Mark discuss the rise and fall of sustainability linked bonds, questioning their credibility and effectiveness compared to traditional green bonds. They delve into challenges aligning climate policies with SLBs, explore liquidity concerns in the market, and analyze the pitfalls hindering the success of this evolving financial product.
Sustainability linked bonds (SLBs) are losing market favor due to ineffective incentives and lack of standardization.
Third-party evaluations of SLBs lack depth and differentiation, raising concerns about credibility and effectiveness.
Deep dives
Sustainability Linked Bonds and their Decreasing Popularity
The podcast episode discusses the decreasing popularity of sustainability linked bonds (SLBs) compared to green bonds. While green bonds have seen significant growth in the past years, reaching nearly a trillion dollars in issuances, SLBs seem to be losing attractiveness in the market. The episode questions why this is happening and raises concerns about the effectiveness and credibility of SLBs as an incentive for issuers to meet targets related to sustainability and climate goals. It suggests that the market for SLBs lacks clarity and standardization, with repetitive evaluative language and boilerplate terms across different bonds. The 25 basis point step-up, which is the common incentive in SLBs, appears to be insufficient to drive real change. The episode concludes by highlighting the need for a reevaluation of SLBs and the possibility of other instruments, such as warrants or separate tradeable components, that could provide more meaningful incentives.
The Questionable Purpose of Sustainability Linked Bonds
The podcast delves into the questionable purpose of sustainability linked bonds. It suggests that while there is a growing demand for green financial products, the SLB market may not be effectively addressing the need for credible commitment and incentivizing sustainable practices. The evaluation of SLBs is often standardized and lacks meaningful differentiation among issuers or goals. The episode explores the limitations of SLBs in generating real incentives and highlights the trade-offs between standardization and tailored incentives. It questions the rationality of issuing bonds that impose significant fiscal penalties for not meeting environmental targets, as it may undermine responsible fiscal management. Overall, the episode indicates a growing realization that the SLB market may lack a clear purpose.
The Role of Third-Party Opinions in Sustainability Linked Bonds
The podcast focuses on third-party opinions (TPOs) in relation to sustainability linked bonds. It highlights the shortcomings and repetitiveness of TPO evaluations, which often fail to provide meaningful insights or differentiate one SLB from another. The evaluative language tends to be standardized, using phrases like 'highly credible' or 'ambitious' without deeper analysis. The lack of legal responsibility by TPOs for verification raises questions about the reliability of their opinions. The episode suggests that the homogeneity of TPO assessments contributes to the lack of credibility and effectiveness of SLBs as incentives for sustainability and climate goals. It also emphasizes the need for better understanding and scrutiny of TPOs in the SLB market.
Exploring Alternative Structures for Sustainability Linked Bonds
The podcast explores alternative structures for sustainability linked bonds (SLBs). It discusses the concept of detachable warrants or separate tradeable components in SLBs, which could provide more flexibility and market appeal. The idea is to allow investors to trade the green-linked part of the bond separately, while holding the vanilla bond concurrently. This would address concerns about liquidity and make SLBs more attractive to both institutional and retail investors. The episode also analyzes the potential benefits and challenges of such structures, including the need for clear objectives and incentives tailored to each issuer. Overall, the episode suggests that reimagining the structure of SLBs could enhance their credibility and effectiveness in driving sustainable practices.
Can Someone Explain What is Happening to SLBs?
A year and a half or so ago, we were working on a paper with UVA’s Quinn Curtis on how the promises being made in the typical “use of proceeds” Green Bonds were empty. In the course of that project, we had loads of conversations with industry insiders, who largely agreed, but said that we were studying a thing of the past. The product of the future was the sustainability linked bond (slb). Unlike boring “use of proceeds” bonds, these had real incentives and were going to replace the 1st generation simplistic products. Now, at the end of 2023, we are hearing that this product is in disfavor in the markets. Why? What’s going on? Not sure we have answers – but we sure have questions and speculations.
Producer: Leanna Doty
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