The often controversial sustainability-linked bond market is beginning to show some signs of maturity as step-up sizes change and a clearer image emerges of how issuers are progressing against their targets.
Research by Barclays released on Friday found that around half of all SLB issuers are on track to hit their targets, with around 21 percent off track and 14 percent on track to hit at least one target on a bond with multiple targets.
Out of 216 SLBs assessed, issuers for 18 bonds reported worse performance against their baseline figures.
On financial penalties, Barclays found that there was no clear correlation between the likelihood of an issuer being on track to hit their target and the size of the step-up in basis points – this changed for issuers with larger bonds and therefore more dollars on the line. These firms are slightly more likely to be on track to hit their targets.
This is also the first-ever year that the majority of step-ups attached to SLBs have been over 25 basis points, with around half of issuers paying 50bps or higher, according to earlier Barclays research.
Adrien-Paul Lambillon, a researcher at the University of Zurich’s centre of competence for sustainable finance, said he would caution against reading too much into the results of the Barclays research on target achievement and step-ups, as there are unlikely to be many issuers with penalties at the top end of the scale.
However, he did say he would expect the size of the penalty to affect the motivation of companies to achieve the target “as SLBs work as an incentive mechanism creating an internal business case for the improvement of certain sustainability metrics”.
The findings of the report more broadly are also reassuring, he said. “They show that issuers have not simply set targets that they knew they would achieve ex-ante (with quasi 100 percent likelihood), but that SLBs actually serve as an incentive mechanism and hold companies financially accountable for their sustainability targets, with the ultimate risk of not achieving them and paying a penalty.”
The first SLBs to have target measurement dates began to report earlier this year, with Polish refiner PKN Orlen and Greek utility PPC both paying out after missing their targets. The biggest name this year to be on the line is market giant Enel, which is expected to miss its Scope 1 intensity target at the end of 2023.
If the issuers which Barclays say are off track on their targets do fail, the bank calculated a $350 million total additional payout.
Radical restatements
While the market is evolving, there are still some issues to be ironed out. The Barclays research found that a fifth of SLBs had restated their baseline KPIs since initial disclosure in the bond framework.
Where targets are tied to percentage decreases or frameworks have accounted for this issue there is less of a problem, but where issuers have committed to reach an absolute number then restatements could make their targets either more or less ambitious post issuance.
Elin Larsson, vice-president in the sustainable capital markets team at Swedbank, told Responsible Investor that issuers may be reluctant to use Scope 3 targets due to the issues in underlying data. Scope 3 is in most cases very material and relevant but the company lacks data from suppliers or end consumers, and so may feel less confident using the data for targets in an SLB.
Jo Richardson, head of research at the Anthropocene Fixed Income Institute, pointed to the retail sector as an example of this. SLB issuers in the retail sector are increasingly making reference to FLAG Emissions, a new category of Scope 3 emissions from the SBTi covering forest, land and agriculture emissions that have not previously been accounted for.
French issuer ELO said in its sustainable financing framework in September that its subsidiary Auchan Retail would likely have to recalculate its emissions baselines and set new targets due to the inclusion of FLAG emissions.
When the calculation exercise is completed next year, the targets in ELO’s framework will be split into Scope 3 FLAG emissions and Scope 3 non-FLAG, and the changes in Sustainability Performance Targets, KPI baseline or baseline date may be applied to outstanding bonds.
Richardson said the deal was “quite powerful” from the perspective of the SLB label as a tool for improving disclosure, transparency and accountability. That said, for investors looking at the deal from a financial perspective, the step-up “is pretty much impossible to price because you don’t even know what your baseline is going to be”.
“This is the payoff for investors using SLBs as a tool for engagement and change versus having a very well and easily defined trajectory.”
Nordic evolution
Turning to the Nordics, investors are also evolving their thinking around the size of step-ups. Nordic issuers have been pioneers in many areas of ESG-labelled bond market, with a number of Swedish municipalities becoming among the first government issuers to raise sustainability-linked debt.
Larsson said that in the Nordic market there was a direct correlation between the size of a step-up and the spread, meaning that high-yield issuers are paying higher penalties while investment grade issuers are paying a lower penalty.
Larsson highlighted two trends she was seeing in the market. Firstly, investment grade issuers are “ready to think in terms of materiality when it comes to target setting which reflects the size and weight of step-ups”, secondly Nordic investors are increasingly asking for more material targets to be linked to a higher penalty.
That said, the Nordic SLB market is less mature compared to the use of proceeds market, so even more discussions around ambitious target setting as well as the size and weight of step-ups is expected, she added.
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