Investors should require companies issuing sustainability-linked bonds to have Paris-aligned targets, according to the Climate Bonds Initiative (CBI).
In a discussion paper exploring credible climate transition strategies, the influential non-profit identified five ‘hallmarks’ for issuers of sustainability-linked bonds (SLBs).
SLBs, which allow companies to borrow more cheaply for general corporate purposes if they meet certain ESG goals over the term of the bond, are one of the most divisive products in the market. While some argue they are key to encouraging entity-level ESG improvements – as opposed to green bonds, which focus on project-level sustainability – others believe the ESG targets being adopted by issuers of SLBs are often opaque and unambitious.
'What took almost a decade to develop in green finance, we need to develop in a couple of years for transition finance' – Sean Kidney
CBI claims the asset class has seen “shaky first examples” and will not grow to its full potential without “rules of the road”. Today, it called for companies to have robust decarbonisation plans – including Paris-aligned targets – accompanied by meaningful action, internal monitoring and public reporting if they want to issue an SLB.
The five hallmarks will form the basis for the certification of financial instruments, the CBI said, and “even how whole companies could be certified”.
Sean Kidney, CEO of the CBI, said that its goal was "the rapid development of a robust and transparent transition finance market that supports acceleration of decarbonisation at the entity level. What took almost a decade to develop in green finance, we need to develop in a couple of years for transition finance".
While sustainability-linked bonds and loans allow new sectors, including heavy emitters, to tap into sustainable financing, some investors say that the coupon step ups – increases in interest rate if the issuer fails to meet sustainability targets attached to the bond or loan – are often too small to be material, and come into effect too close to maturity. Others have criticised the targets themselves, saying that they are often not material to the core of the issuer’s business activities.
CBI said that it could be hard to determine if the key performance indicators (KPIs) selected by the issuer were the appropriate ones, and that many were “not ambitious enough to align with the transition pathways that will be needed for achieving Net Zero by 2050”.
Paris-aligned targets should be based on sector-specific decarbonisation pathways, and include company-specific KPIs to measure alignment or outperformance, the paper said. Targets should be set for the short, medium and long term, as well as including Scope 1, 2 and 3 emissions.
Issuers should have approval from their boards for the targets, strategies and associated financing plans.
Chosen KPIs should be publicly disclosed alongside a narrative transition strategy, with annual reporting of progress – a stipulation also included in the International Capital Markets Association’s Sustainability-linked Bond Principles. All publicly-disclosed information should be supported by a verification assurance report from an independent external verifier.
The CBI invites input from the market on the discussion paper.