Two loan deals in April 2017 — for Unibail-Rodamco and Philips — were the first large ones in which, if the borrower hit a sustainability target, the margin would be reduced, while if it performed badly, it would rise.
This format has proved very popular. Now the Schuldschein market, halfway between loan and bond, is getting its first taste. Engineering firm Dürr is raising €150m, with spreads that can be cut or raised, based on its sustainability rating from EcoVadis.
There is no technical reason why bond markets should not adopt this.
To most bond investors and bankers, it remains an alien concept of which they are sceptical. Investors would dislike having to price uncertain outcomes, they say.
Wrong. Many deals are already more complex than this, with call options, step-up coupons for rating downgrades and the like. The coupon change in Dürr’s case is a tiny 2bp. For that, it must improve its ESG rating a long way, from 51 out of 100 to 62.
If investors believe good ESG makes companies better risks, they should be happy to pay 2bp in future, for a major ESG improvement that ought to tighten the spread more.
Lack of bonds is a common complaint of green bond investors. While not exactly the same product, this would broaden the array of socially responsible debt available. A company with no green projects to fund can still adhere to good ESG principles.
Green bond purists will take a while to get used to it. They like to feel their money is going to green ends. But the issuer was usually going to do those activities anyway, and the investor remains exposed to all its brown activities. With an ESG ratchet, the whole organisation has an incentive to improve.
Who wants to try it first?