Sustainability-linked bonds were once heralded as the key to bringing ESG finance to the masses, but it quickly transpired that they would not be the harbinger of sustainability they purported to be. Yet while the glory days of the structure might already have passed, they remain an important way for companies to transition to greener, better practices.
SLBs have lost their lustre. Syndicate bankers in Europe, the home of ESG finance, complain that investors have zero interest in a company’s overarching key performance indicators, or the sustainability performance targets (SPTs) that are specific to each deal.
ESG-focused investors paint a different picture, but many of them are still unhappy with where the market is. KPIs are not ambitious enough, the financial reward is negligible to the point of worthlessness, and with each issuer having its own idiosyncratic SPTs, deciphering each deal’s green credentials is a quagmire of assumptions and overly quick decisions made between the mandate announcement and the deal printing a day later.
Forced evolution
Although this is a sorry tale, tension in the market is a good thing. It will, hopefully, spur change for the better: in particular, the application of SLBs.
When they were first created by Italian energy company Enel, which investors frequently site as the green standard for ambitious SLB targets, everyone and their treasurer was trying to work out how to tack sustainability onto their capital structure.
It was a frequent joke among DCM bankers in 2019 and 2020 that every talk they had with clients was about a bank product plus sustainability-linked. Unsurprisingly, this did not encourage every deal to be well thought out, and a lot of ill planned nonsense slipped through in the glut of deals that followed. Investment grade corporates were often using KPIs that, when forecast out to 2030, 2040 or 2050, got nowhere near the net zero ambitions of many of the world’s governments.
The hyper competitive and usually loss leading syndicated loan market was particularly insidious in its relaxing of standards. It became fairly common for loans bankers to let borrowers sign a ‘sustainability-linked loan’ that did not have any targets attached to it at all, with a pinkie swear promise that the issuer would come up with targets at one point before maturity. Often, borrowers put out a press release telling the world how green they were, despite having done nothing other than sign a regular loan.
But, rather than ditch SLBs as a failed experiment, now is the time to better recognise their strengths and grow on their achievements. They allow companies without green assets to raise ESG funding that can be used for general corporate purposes and the amounts do not have to be enormous, because they are not linked to specific asset spending. They work best when investors have the time to look at the structures fully, away from a flow market like investment grade corporate bonds can sometimes become.
The high yield market already largely works in this way, where smaller deals for non-green companies with long lead times proliferate, making that market a prime candidate for a boom in SLBs, and one where the structure makes solid sense. Unfortunately, there have already been murmurings of underhanded practices here, in particular investors seeing STPs that are not tested until after the first call date of a deal, but a green optimist could put these down to growing pains.