The sustainability-linked bond market has exploded to $80 billion in issuance this year, even as some investors question the ‘green’ certificate of debt that can be used to finance for a variety of corporate initiatives.
The first deal in this nascent sector only took place in 2019, but in the face of growing attraction between businesses and their creditors, global issuance has increased almost ninefold since by the end of 2020, according to Environmental Finance.
Sustainability-linked bonds lack the stricter criteria for green bonds, where debt is raised to fund specific green projects. Issuers do not face tight restrictions on how the proceeds are used, but must instead agree to a number of goals inspired by the environment, society, and governance.
Failure to meet those commitments often results in increased interest payments, increasing the issuer’s borrowing costs. But the examples to date show that such penalties are relatively small.
US generic drugmaker Teva, which has been embroiled in the US opioid crisis, recently issued the largest sustainable bond issue, 5 billion dollars fundraising aligned with the goals of increasing access to medicines in low- and middle-income countries, and reducing the company’s greenhouse gas emissions.
If Teva fails to meet those goals, it will only have to split a fraction of a percentage point in higher payouts to investors — the equivalent of less than $10 million in annual interest. That additional interest will also only apply after the May 2026 assessment date to bonds that expire just a few years later.
Matt Todd, who analyzed Teva’s deal with rating agency S&P Global, said the penalty “doesn’t matter” to the debt’s rating. More importantly, borrowing costs are low due to rampant investor demand for sustainable debt. “It’s good for their cash flow,” he said.
Overall, sustainability-linked bond advocates say that the rapid growth of the market heralds green debt slowly becoming mainstream – allowing companies to make a public statement about sustainability that investors can claim. investors can hold, even if they may not have suitable projects to finance themselves. green bond market is more established.
However, critics argue that such an expansion is more reflective of the less demanding requirements of the market, allowing companies to build on their new-found ESG commitments without having to do a lot of work to prove them.
“I think the bond with the long-term bond holds great promise,” said James Rich, a portfolio manager at Aegon. “But the reality, unfortunately, is that the structures and penalties for not reaching goals are mostly not fundamental enough to drive real and real change among these companies.”
Teva is not an isolated example. Coupon raised on a $900 million bond released earlier this year of Level 3 Grants, a subsidiary of Lumen Telecommunications, is just 0.125 percentage points.
Indian cement maker UltraTech Cement meanwhile has raised $400 million through a 10 year sustainable bond in February. The deal includes a much larger 0.75 percentage point coupon increase if the company fails to meet certain goals around reducing carbon emissions. However, the assessment date falls just six months before the debt is due, making its effect on the company’s interest payments negligible, according to people familiar with the bond.
Investors remain skeptical about how the enduring association moniker has prompted companies to make meaningful change.
“There is a huge gap between what we need and what we are seeing,” said Charles Portier, portfolio manager at Mirova.
However, others hoped for more. Scott Mather, head of sustainability investments for asset management firm Pimco, forecasts that the sustainability bond market embraces – including green bonds, social bonds, sustainability-linked bonds and others – could reach $10 billion within the next 5 years from the current level of just over $2 billion.
Mather also says that sustainability-related debt should be seen as the “big brother” of the green bond market rather than its smaller sibling.
“The fact that companies are publicly committed to sustainability goals is very powerful,” says Mather. “It creates an expectation among their stakeholders, customers, employees and investors, that they are committed to sustainability.”
These are also early days, and bankers note that while issuance is growing rapidly, it’s still not enough to meet demand. Until that point, borrowers have the upper hand, and that usually means lower borrowing costs and smaller penalties.
Anjuli Pandit at HSBC, the bank that led both the Teva and UltraTech deals, says penalties aren’t the only thing that matters either.
“Investors don’t buy it hoping they make a move or they can punish the company,” Pandit said, noting that more punitive penalties could get issuers fired. “This tool is about holding companies accountable for these goals and providing investors with data to track that. We want that data. We want to open the door between the issuer and the investor for this conversation to take place.”
As issuance increases and the balance of power shifts, investors may end up demanding more challenging targets, demanding more granular data, or imposing harsher penalties.
For now, however, some investors remain motionless. “We have seen very few examples that meet our requirements to qualify for our sustainability themed investment strategies,” says Rich. “They’re just too wise-romantic.”
Teva declined to comment. Lumen and UltraTech did not respond to requests for comment.
