The market for sustainability-linked bonds has boomed to reach $80bn in issuance this year, even as some investors question the ‘green’ credentials of the debt that can be used to finance a broad array of corporate initiatives.
The first deal in this nascent sector only took place in 2019, but in a sign of its escalating appeal among businesses and their debt holders, global issuance has grown almost nine-fold since the end of 2020, according to Environmental Finance.
Sustainability-linked bonds lack the more rigorous criteria placed on green bonds, where debt is raised to finance specific green projects. Issuers do not face tight restrictions on how proceeds are used, but must instead agree to certain environmental, social and governance inspired targets.
Failure to meet those pledges typically results in a step-up in interest payments, raising the issuer’s borrowing costs. But examples so far suggest such penalties are relatively small.
US generic drugmaker Teva, which has been embroiled in the US’s opioid crisis, recently issued the largest sustainability-linked bond, raising $5bn pegged to targets to increase access to medicines in low and middle-income countries, and to reduce the company’s greenhouse gas emissions.
Were Teva to fall short of those goals, it would have to fork out just a fraction of a percentage point in higher payments to investors — equivalent to less than $10m of additional annual interest. That extra interest would also only apply after the assessment date in May 2026 for bonds expiring just a couple of years later.
Matt Todd, who analysed Teva’s deal for rating agency S&P Global, said the penalty was “not material” to the debt’s rating. More significant was the low borrowing cost achieved from rampant investor demand for sustainable debt. “It’s good for their cash flow,” he said.
Broadly, proponents of sustainability-linked bonds say that the market’s fast growth heralds green debt moving into the mainstream — allowing companies to make public declarations about sustainability that investors can hold them to, even when they may not have a suitable project to finance themselves through the more established green bond market.
However, critics argue that such expansion is more reflective of the market’s less strict requirements, allowing companies to brandish their new found ESG commitments without having to do much work to substantiate them.
“I think there is tremendous promise in sustainability-linked bonds,” said James Rich, a portfolio manager at Aegon. “But the reality, unfortunately, is that the structures and the penalties for not achieving the targets are mostly not substantial enough to drive real and true change among these companies.”
Teva is not an isolated example. The coupon step-up on a $900m bond issued earlier this year by Level 3 Financing, a subsidiary of Telecoms company Lumen, was just 0.125 percentage points.
Indian cement manufacturer UltraTech Cement meanwhile raised $400m through a 10-year sustainability-linked bond in February. The deal included a much larger 0.75 percentage point coupon increase if the company fails to reach certain targets around reducing carbon emissions. However, the assessment date falls just six months before the debt reaches maturity, making its effect on the company’s interest payments negligible, according to people familiar with the bond.
Investors remain sceptical about how far the sustainability-linked moniker pushes companies to make meaningful change.
“There is a huge gap between what we need and what we are seeing,” said Charles Portier, a portfolio manager at Mirova.
However, others are more hopeful. Scott Mather, in charge of sustainable investments for asset manager Pimco, forecasts that the overarching sustainable bond market — including green bonds, social bonds, sustainability-linked bonds and others — could reach upwards of $10tn over the next five years from its current level of just over $2tn.
Mather also said that sustainability-linked debt should be seen as the “big brother” of the green bond market rather than its smaller sibling.
“The fact companies are committing publicly to sustainability goals is powerful,” said Mather. “It creates an expectation among their stakeholders, their customers, employees and investors, that they are committed to sustainability.”
These are also early days, and bankers note that despite issuance rising rapidly, it is still nowhere near the amount needed to satiate demand. Until that point, borrowers have the upper hand, and that typically means lower borrowing costs and smaller penalties.
Penalties are also not the only thing that matters, said Anjuli Pandit at HSBC, the lead bank on both the Teva and UltraTech deals.
“Investors aren’t buying it in the hope they get the step-up or that they can punish the company,” said Pandit, noting more punitive punishments may put issuers off. “This instrument is about companies asking to be held accountable on these targets and giving investors data to track that. We want that data. We want to open up the door between issuers and investors to get this conversation going.”
As issuance increases and the balance of power shifts, investors may ultimately be able to demand more challenging targets, request more granular data or apply harsher penalties.
Nonetheless, for now, some investors remain unmoved. “We have seen very few examples that have met our requirements to be eligible for our sustainability themed investment strategies,” said Rich. “They are just too wishy-washy.”
Teva declined to comment. Lumen and UltraTech did not respond to a request for comment.
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