SLB issuers ‘likely to miss majority of 2022 and 2023 targets’

The majority of sustainability-linked bonds with target measurement dates in 2022 and 2023 are in danger of not hitting their goals, according to analysis from Barclays.

The bank identified five index-eligible SLBs with observation dates at the end of 2022, and 15 with observation dates in 2023. Of the five measured at the end of 2022, question marks remained over whether three would hit their targets, while only three of the 2023 targets have been hit so far.

The uncertainty is largely driven by energy company Enel, which accounts for one of the three bonds off track in 2022 and nine of the 12 in 2023. Dutch chemicals firm Nobian and Greek utility Public Power Corp (PPC) account for the other two 2022 targets, while brakes manufacturer Knorr Bremse, water management firm SAUR and PPC make up the remaining unachieved 2023 targets.

Enel, which was one of the first issuers to come to the market in 2019 and now exclusively issues SLBs, needs to have increased its renewables installed capacity by two percentage points since June to hit the 2022 target. While this would be in line with the firm’s historical average, it only saw a 0.5 percentage point increase in the first half of last year. Preliminary full-year results will be published on 9 February.

Enel’s SLBs with measurement dates in 2023 are all linked to a Scope 1 carbon intensity target of 148 grammes per kilowatt hour of energy produced, while the current intensity stands at 227. This would be in line with 2021 levels, but Barclays said there is a possibility of the firm missing the target if coal usage remains high to alleviate pressure on gas supply.

Missing the targets on all nine SLBs in 2023 would result in increased interest costs of €120 million over the lifetime of the bonds, Barclays calculated.

However, the prospectuses for Enel’s SLBs include language permitting a step-up to not occur due to “an amendment to, or change in, any applicable laws, regulations, rules, guidelines and policies or a decision of a competent authority, applicable to and/or relating to, or such that… the closure of the thermo-electric power plants owned by ENEL, or its consolidated subsidiaries or joint operations, is delayed”.

Barclays suggested that this language is relevant to both Enel’s renewables and emissions intensity targets. Enel did not respond when asked whether it would commit to paying any incurred step up.

PPC’s predicament

Two of the other SLBs not currently on track to meet their targets belong to Greek state-owned utility PPC.

There has been speculation that the firm may miss its emissions cuts. BlueBay Asset Management portfolio manager Robert Lambert said in December that he expected it to miss both.

PPC has tied its 2022-measured SLB to a 40 percent reduction in Scope 1 emissions versus 2019, while the 2023 target is 57 percent. At the end of 2021, it had achieved a 31 percent reduction, but warned in sustainability reporting that emissions may have risen due to the war in Ukraine and an increased dependence on coal.

Lambert said previously that he would be watching whether PPC tried to get an exemption, given that the missed target had been driven by government policy. “Compliance has been largely untested to date, given it is still a nascent asset class,” he said.

Trading troubles

Barclays’ research also addressed the expected performance of an SLB that fails to hit its target. The analysts noted that, while the bondholder would benefit from the additional coupon payment, this gain could be offset if the deterioration in the ESG quality of the issuer prompts forced sales and thus spread-widening.

However, Barclays said it was “not convinced” that many investors would be forced sellers of failed SLBs, given that in some sectors this will be due to external factors such as the war in Ukraine. Few investors consider SLBs to be sustainable investments under SFDR, and it is uncommon for them to be held in dedicated sustainable debt funds.

Mitch Reznick, head of sustainable fixed income at investment manager Federated Hermes, also said in December that, instead of simply excluding a failed SLB, he would “rather look at the reasons why and understand that there are external factors that are not within their control that make it incredibly difficult to hit their target or mean that another sustainability factor would have a negative outcome”.

Barclays expects SLBs likely to miss their targets to trade tight to the issuer’s curve ahead of the step-up. In the broader market, SLBs tend to trade in line with non-ESG equivalents, which the report authors said suggests the market “is generally pricing the embedded options at zero because investors see little likelihood that targets will be missed as they are typically unambitious”.