Innovations in Sustainable Finance #4 Stéphanie Mielnik | Sustainability-Linked Bonds
May 2, 2023
auto_awesome
Stéphanie Mielnik, an expert in sustainable finance and sustainability-linked bonds, discusses the growth and market pricing of SLBs. They highlight the importance of ambitious targets and criticize easily achievable ones. The chapter also explores the concept of SLBs and the difference between targeting emissions intensity and absolute carbon emissions. Additionally, they discuss the feasibility of achieving further emissions reductions after initial goals are met and analyze the pricing discrepancy of SLBs.
Sustainability-linked bonds (SLBs) have gained attention for their interest rate tied to sustainability targets, promoting alignment between financial incentives and sustainability goals.
Market pricing of SLBs should incentivize issuers to set ambitious targets, driving meaningful sustainability milestones.
Deep dives
SLBs: An Exciting and Successful Innovation in Sustainable Finance
Sustainability Linked Bonds (SLBs) have experienced significant growth in the past few years, totaling around $280 billion USD. While still a small part of the overall market, SLBs have shown promise in driving the sustainability agenda forward. The Anthropocene Fixed Income Institute (AFII), an NGO, focuses on empowering global fixed income markets in the climate transition. By providing market-based research and advocating for the pricing of high-carbon investments, AFII aims to align investor portfolios with ambitious climate targets. The choice to focus on the fixed income market is driven by its size, influence, and potential to promote sustainability. SLBs, in particular, have gained attention for their interest rate tied to sustainability targets. These targets, known as Sustainability Performance Targets (SPTs), are incorporated through a structured framework validated by second-party opinion providers. While some criticisms exist, such as the potential for greenwashing or issuers manipulating targets, AFII promotes the pricing of SLBs based on the ambition of their targets. They believe that market pricing should incentivize issuers to set ambitious targets and achieve meaningful sustainability milestones.
Understanding SLBs and their Innovative Structure
SLBs, also known as sustainability link bonds, are a type of bond where the interest rate is tied to one or more sustainability targets. For example, a company issuing an SLB may offer a lower interest rate if they achieve specific sustainability goals, such as reducing carbon emissions. The target, known as a sustainability performance target (SPT), is defined in a sustainability link framework and verified by second-party opinion providers. This structured approach aims to ensure transparency and credibility in the market. SLBs are not a completely new concept, as similar structures have been applied in other credit instruments like sustainability-linked loans and sustainability-linked swaps. However, the unique aspect of SLBs is the focus on corporate-wide sustainability performance targets. While SLBs can offer benefits in terms of aligning financial incentives with sustainability goals, it is important to carefully evaluate the ambition and materiality of the targets and the independence of second-party opinion providers.
Challenges and Considerations in the SLB Market
The SLB market faces certain challenges, including criticisms of lack of ambition, low coupon step-ups, and potential conflicts of interest in the second-party opinion provider process. Some SLBs have been criticized for setting easily achievable targets, leading to accusations of greenwashing. Additionally, the coupon step-ups offered in case of target failure have been deemed too low in some instances. Second-party opinion providers, although crucial for validating sustainability frameworks, may face conflicts of interest as they are paid by issuers. Despite these challenges, AFII emphasizes the importance of market pricing that reflects the ambition of SLB targets. By appropriately pricing coupon step-ups based on target ambition, issuers are incentivized to set and achieve meaningful sustainability goals. This would drive the transition to a more sustainable economy.
The Potential Impact and Future of SLBs
SLBs have the potential to influence sustainability efforts across industries and promote the transition to a low-carbon economy. They create incentives for issuers to improve their sustainability strategies and achieve meaningful targets, which could lead to environmental and social benefits. It is essential for investors to carefully evaluate the ambition and credibility of SLBs, considering factors such as the issuer's sustainability strategy, alignment with global frameworks, and the materiality of selected KPIs. Simplification of SLB structures, increased focus on nature-related KPIs, and improved pricing standards are desired for the future. AFII hopes to see the market embrace SLB pricing standards and an increased number of KPIs linked to nature as part of global sustainability efforts.
In this episode, Stephanie and I delve into sustainability-linked bonds (SLBs) to explore their potential benefits and risks. SLBs have grown to a USD 280 billion market and represent an exciting alternative to green bonds in the sustainable debt market. When issuing an SLB, companies pledge to reach a sustainability performance target as part of the contract. If the company does not reach the target, the bond investors receive an additional “step-up” coupon. We analyze the example of a recent Air France KLM issue. One of Stephanie’s key points is that market pricing should reveal which SLBs have ambitious targets.
Here are a few links if you want to follow up on some of the points we cover.
