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Bonds 29 Jun 2020

How sustainability-linked bonds will breathe life into the market

Growing interest in sustainability across all segments of society has led to innovations in sustainable finance offerings, specifically in the world of corporate financing. Issuances of bonds linked to sustainability criteria are among the latest market developments. Analysts at BBVA Global Markets Research explain the basics and share with us their view of the product.

What is a sustainability-linked bond?

Sustainability-linked bonds are also known as KPI-linked bonds or SDG-linked bonds (where KPIs are key performance indicators related to sustainability, and SDG refers to the UN’s sustainable development goals).  Unlike traditional sustainable bonds, which have to prove that the capital they raise will be allocated to specific sustainable projects, sustainability-linked bonds qualify as sustainable because they are issued with a structural component (for example, a coupon) that varies depending on whether or not a defined environmental, social, and/or governance (ESG) objective is achieved.

Thus, although classified within the same universe as ‘traditional’ green, social, and sustainable bonds where proceeds are specifically earmarked for ESG projects, the key difference is that income from sustainability-linked bonds are issued for general corporate purposes.

Within sustainability-linked financing products, we can find both bonds and loans. In fact, in recent years this type of product has become very popular in the sustainable loans space. Nonetheless, It was not until Q4 2019 when the first bond with a coupon linked to a sustainability indicator was issued. Despite the high expectations, as of today there has been no additional activity in this area.

ICMA publishes its guide to sustainability-linked bonds

The International Capital Markets Association (ICMA) has released a guide that serves to provide governing practice and standards for issuers of, structurers of, and investors in this relatively new type of instrument. Given that ICMA was the supervisory body for green and social bonds for which they have already established specific principles, analysts at BBVA Global Markets Research are confident the new guidance will stimulate short and medium term sustainability-linked bond issuance.

The Sustainability-Linked Bond Principles (SLBP) consist of five components: the selection of sustainability key performance indicators (KPIs); the calibration of sustainability performance targets (SPTs); bond characteristics; reporting; and verification.

ICMA focuses its recommendations on the disclosure of the sustainability KPIs and the SPTs, directing issuers to be sufficiently clear about what indicators have been selected and how they plan to reach the defined target. Also key is the recommendation that the KPIs and targets should be benchmarked against sector standards, as it gives investors a sense of how significant these KPIs and targets are relative to other products in the market.

Expectations for the asset class: it has room to grow

BBVA Global Markets Research analysts believe sustainability-linked bond issuance will increase as a direct response to the release of these principles. They expect issuance activity to begin with issuers of certain characteristics, for example those who are already well-known by ESG investors and who have a potentially strong ‘green curve’ or a previous history of green bond issuance.

These instruments will serve to complement existing sustainable bond structures and to create entry opportunities in the space for those issuers for whom the issuance of traditional sustainable bonds is not viable, or is of little interest.

BBVA’s analysts maintain that these ICMA principles will inevitably represent an inflection point in both issuer and investor interest in sustainability-linked issuances. And, despite the outstanding questions related to potential structures and innovations, they expect issuance to get underway imminently.

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