SLB supply no longer likely to outstrip use of proceeds in near future, says Barclays

Bank had forecast SLBs would overtake use of proceeds in 2023, but quality concerns and lack of premium have slowed growth.

Barclays has said it no longer expects the supply of sustainability-linked bonds to outstrip use of proceeds issuance in the near future, as borrowers turn to green bonds in search of pricing discounts and investors grow increasingly concerned over quality.

In a research report looking at corporate issuance in 2022, Barclays noted that SLB volumes contracted by the highest percentage versus 2021, seeing a fall of 37 percent. By contrast, green and social bond issuance only fell by 15 percent and 11 percent respectively, while the sustainability bond market saw a decline of 34 percent.

A year ago, the UK bank forecast that SLBs would move closer to the issuance levels of use of proceeds in 2022 and exceed them in 2023. It said many high-emitting sectors would be more likely to use an SLB to enter the sustainable debt market due to greenwashing fears around green bonds, as well as a continuation of the trend for high-yield issuers to choose SLBs over use of proceeds structures.

Barclays has now withdrawn this forecast. The researchers found no evidence that SLBs were trading differently to non-ESG equivalents, suggesting that in an environment of rapidly rising interest rates issuers would be more likely to choose a green bond to try and save on financing costs.

On the investor side, Barclays said SLB volumes may also have been stunted due to concerns around greenwashing in the market, with complaints over small penalties, unambitious targets and immaterial KPIs. The preference of high-yield issuers for SLBs also affected supply as activity in the segment collapsed in 2022.

Charlotte Edwards, Barclays’ head of ESG FICC research, told Responsible Investor that when the bank made its forecast for 2022, the SLB market was still at a very nascent phase of development and few market participants had decided what they viewed as a good quality security.

“This year there has been considerably more focus on the structure of these instruments and a growing number of investors we speak to are concerned about their quality, particularly related to the materiality of KPIs, the ambitiousness of targets and the size of penalties,” she said.

“Our thesis was that theoretically all bonds issued could come in a sustainability-linked structure, whereas growth in the use of proceeds market is capped by the amount of ESG projects being funded. Put simply, the maximum annual issuance of use of proceeds bonds is equal to the incremental investment in ESG projects, while the maximum annual issuance of SLBs is much greater, equal to the issuance from all companies that are setting out to improve one or more ESG KPIs.”

While all four ESG-labelled formats saw declines in absolute terms, final-year figures show continued growth of the segment as a proportion of overall bond issuance.

In the euro investment grade market, the proportion rose from 25 percent to 29 percent, and ESG-labelled debt made up an all-time high of 8 percent of investment grade bonds issued in dollars. Proportions shrank in the sterling-denominated investment grade and euro-denominated high-yield market, but Barclays noted that limited issuance in the broader market may have skewed these results.

Among other interesting findings noted by Barclays was that issuance levels only exceeded their 2021 levels in January and August, and that the contribution of emerging market issuers to the green bond market almost doubled, rising from 9 percent in 2021 to 16 percent of total issuance last year.