Limited fallout forecast for bondholders as first index-eligible SLB misses target

The failure of Greek state-owned utility Public Power Corporation (PPC) to hit emissions targets tied to its first sustainability-linked bond are unlikely to result in additional financial impact, according to market participants.

PPC raised €650 million from its first SLB in March 2021, followed by a €125 million tap in the same month. Investors were promised an extra 50 basis points on the coupon should it fail to cut Scope 1 emissions by 40 percent by the end of 2022.

In a statement last week, PPC confirmed that it had only managed to reduce emissions by 36 percent, meaning the step up would take place. The additional coupon payments will cost around €4 million a year until the bond’s maturity in 2026, the issuer said.

The deal is the first index-eligible SLB to miss its attached sustainability target, although Polish refiner PKN Orlen became the first issuer to pay a penalty last year after a decrease in its ESG score triggered a coupon step-up.

PPC management attributed the firm’s failure to hit its target to an increase in lignite generation to ensure Greece’s energy security during the energy crisis.

In a note published after the announcement, Fitch Ratings forecast a “limited negative impact” on PPC’s cost of debt and said it did not expect “any meaningful changes in the bondholder base and its pricing in the secondary market”, despite the fact that around 60 percent of the bonds are owned by ESG-labelled funds.

Explaining its forecast, Fitch said that it expected the main holders of the bond “to factor into their decision-making that the failure to meet the target is unrelated to PPC’s operating performance, a change of strategy or a weakening of its sustainability focus”.

PPC issued a second €500 million SLB in July of 2021, which is tied to a 57 percent reduction in emissions. Fitch said it expected “a similar situation to the present one” when it measures at the end of 2023.

The European Bank for Reconstruction and Development (EBRD), which bought €50 million of the PPC bond at launch, indicated to Responsible Investor that it still viewed the issuer favourably.

George Gkiaouris, the EBRD’s regional head of energy for South Eastern Europe, told RI that the bank understood PPC’s failure to be “temporary” and that it was driven by “last year’s exceptional energy security situation”.

The EBRD views PPC as fully committed to decarbonisation and renewables expansion, Gkiaouris added, noting that the firm has a target to install 5GW of renewables in Greece by 2026. “We consider that PPC is implementing one of the most ambitious and aggressive decarbonisation strategies in the EBRD regions and we remain fully supportive of PPC’s plans.”

There has been widespread speculation as to how SLBs that miss their targets will perform. While the failure to hit a target will trigger a small increase in coupon – generally 25 basis points – this could be offset for bondholders if the move prompts selling by ESG funds.

Fixed income think tank the Anthropocene Fixed Income Institute (AFII) has warned that investors would especially need to take into account the impact of the bonds being dropped by ESG index funds.

Jo Richardson, head of portfolio strategy at the AFII, told RI that she was not seeing much relative movement between the two PPC SLBs on the secondary market.

She expected some outperformance from the “triggered” bond as it will now receive a 50bps step up, but the change in sustainability performance “will likely affect the company and all its bonds”.

If the triggered SLB outperforms over time, it would demonstrate that the bonds are an effective hedge against poor sustainability performance, she added.

Investors are also watching Italian utility Enel and Dutch chemicals firm Nobian, which have 2022 measurement dates and may yet miss their targets.

Charles Smith, senior funding officer at the EBRD, noted that if investors expect the targets attached to SLBs to be ambitious, there will inevitably be cases where an issuer fails to hit them. A sell decision would be “highly contextual”, he added, and would depend on the issuer’s wider commitment to the transition and its sustainability objectives.

AFII’s Richardson noted that, if no issuer ever missed a target, “the market could legitimately wonder whether company’s targets are ambitious enough”.

“It may seem unfair that a company has to pay financial penalties due to policy changes outside of its control,” she said. “However, if the company is able to reassure the market that they remain committed to strong sustainable performance, we would expect they can avoid a widespread selloff.”