Sustainability-linked Bonds (SLB) / CPs in a nutshell
The KPI-linked format has been applied to the bond market in the form of the SLB, helping drive forward actions to embed transparent and credible sustainable targets into the debt coupon mechanism.
Since ENEL’s first issuance of the sustainability-linked Bonds and Commercial Paper in 2019, the market has broadly adopted this instrument with cumulative issuances of $175+ billion from 230 issuers in 53 countries.
What are the 5 core components of SLBs?
- ESG Key Performance Indicators (KPIs): CO2 emissions, Renewable Energy production, Sum of recycled products, etc.
- Sustainability Performance Targets (SPTs): consisting of one or more trigger events to express near-to-medium-term sustainability priorities.
- Variation Mechanisms: could be related to either Financial and/or Structural changes in the Bond characteristics.
- Regular Reporting: usually annual for all KPIs defined.
- External verification: the assessment of the alignment of KPIs and SPTs from third parties.
If you want to learn more about the history and the 5 components of sustainability-linked bonds, you can read our previous article about SLBs.
Which market actors are involved in structuring KPI-linked instruments?
A successful KPI-linked debt must be a collaborative effort between multiple stakeholders and different departments within the issuing company. Therefore, it is not only the finance department that implements the KPI-linked debt program, but also sustainability teams, which is a positive change to advance the company’s sustainability agenda.
- ESG banking experts are key players in this new ESG segment of DCM. As issuers seek expertise and data, they are at the center of market developments and innovations and can appropriately assist companies in structuring their SLB framework and transactions, with the help of lawyers.
- Third-party ESG agencies (mostly consulting firms) can also be part of the process to guide companies in setting up the right organizational structure to select and report on material KPIs and science-based ESG targets.
- With Investors, we can see the changing attitude toward SLBs. In the beginning, most investors were waiting to see this tool mature further. Now we clearly see this trend fading as more SLB transactions are issued, giving us a better sense of the impacts and variation mechanisms being used by market participants.
For instance, Climate Bonds Initiative’s Primary Market H1 2022 report stated that “Investor appetite drives pricing benefits for sustainability-linked bonds”. Additionally, at the end of 2022, Bloomberg reported the first known financial penalty for missing a sustainability target, which is likely to increase investors’ confidence and appetite toward SLBs even more.
What are the SLB KPIs & mechanisms used by the market?
SLB KPIs
Looking at all the KPIs used by the market, we can see that:
- Almost all SLB issuances have multiple KPIs linked to the transaction.
- A growing share of issuers are including ESG ratings as KPIs for SLB transactions
- 80% of SLBs are linked to environmental KPIs according to the CMS study. This is mainly due to a greater environmental focus across the market and in the minds of most investors.
Some of the most frequently used KPIs by the market:
- Scope 1 & 2 CO2 emissions reduction
- Saved / Avoided CO2 emissions for clients
- Renewable Energy consumption/generation
- Sustainable sourcing indicators (relevant to each issuer)
SLB Variation mechanisms
An obvious fact is that financial variation mechanisms are more commonly used in SLB transactions, compared to structural mechanisms (such as label termination or debt redemption).
Illustrative example: Enel
The Italian utility issuer is the first one in the world to launch Sustainability-linked debt products in 2019. They switched their Bond & Commercial Paper (ECP) programs to SLB format and linked medium-term targets with variation mechanisms. They have implemented 2 different mechanisms: step-up coupons for their Bond issuances and label termination for the CP program.
Today, the step-up coupon and the premium payment are the most widely used financial variation mechanisms. They both imply that if the target (SPT) is not met for the triggered event, the issuer will incur a negative penalty and pay a higher coupon to SLB investors.
We also note that a larger share of SLB instruments includes a penalty if the issuer does not provide the KPI report on time.
As for the coupon step-down mechanism, it is currently less incorporated in SLB transactions. One thing we can say for sure is that this mechanism is frequently used by corporates, but not so much by SSA players.
Finally, the remaining financial mechanism used by the market is the payment to third-party organizations (for instance, NGOs), which accounts for 30% of KPI-linked loans and less for debts.
What are the main steps and paperwork needed to issue SLBs?
1. Set up KPIs, targets, and mechanisms in collaboration with dedicated teams
- Select consistent and reliable KPIs that are core to the company’s ESG ambitions;
- Define sustainability performance targets for each KPI to measure progress on the short- to medium/long-term;
- Benchmark the KPIs and targets used by the market players.
2. Build & communicate your sustainable framework
- Create a framework in line with the ICMA principles and market practices.
- Specify the KPI metrics, methodology, mechanism while providing historical data;
- Share the framework with banks and investors while negotiating debts.
3. Monitor your KPI reports and target impacts
As with green or social bonds, companies will report annually on the sustainability KPIs included in the framework and debt transactions. For each sustainability performance target, the report will be linked to an impact variation mechanism, predetermined in the framework. The positive/negative impact should be monitored and executed adequately.
4. Update frameworks and KPIs according to the market standards
The catch with SLBs is that the standards around them are developing, expanding, and shaping continuously. Therefore it is important for issuers to review and update their frameworks and KPIs regularly to stay in sync with the latest market standards.
With time, KPIs will harmonize, and the documentation will standardize in relation to regulations and market practices. We believe that the digitalization of these steps is key to bringing efficiency to the change management of all companies. And that’s exactly what we’ve been working on for the past 3 years!
How We Simplify Sustainability-linked Bond / CP structuring and issuance ?
At Onbrane, we’ve been developing our ESG+ debt module to take the complexity away from issuing sustainable debt products, including Sustainability-linked instruments.
The result is a one-stop shop ESG solution to promote, negotiate, and capture investment opportunities in the sustainable debt markets.
We cover every step of the process – from framework creation to choosing standardized KPIs, issuing debt, reporting the impact, and benchmarking ESG data. Most importantly, all the stakeholders, issuers, intermediaries, advisors, and investors, can work collaboratively, enjoying streamlined workflows and transparency.
Get on board
Want to take your SLB capabilities to the next level? Our ESG+ debt module can be exactly what you’re looking for.
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