How sustainability-linked bonds ease access to ESG finance

Issuers are not required to dedicate proceeds to green or social projects and can instead use them for general corporate purposes

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The Covid-19 pandemic intensified the world’s focus on sustainability and accelerated significant growth in the sustainable finance sector.

As a result, the issuance of green, social, sustainability and sustainability-linked bonds (GSSSB) has increased.

Despite a dip in issuance in 2022, cumulative GSSSB issuance has grown in recent years and passed the $3 trillion mark in the first half of this year.

Considering weaker issuance trends in global bond markets in the first half of this year and the likelihood of it continuing in the second half, S&P Global Ratings recently lowered its forecast for GSSSB issuance to $865 billion for 2022, compared with a February forecast of $1.5tn. This represents a 16 per cent decrease compared with the $1tn GSSSB issuance in 2021.

However, this decrease is largely in line with current expectations for global bond issuance, which we also forecast to decline by 16 per cent.

We believe green bonds will remain the most popular type of GSSSB, especially as financial services and international public finance issuers increased their share of total green bond issuance, accounting for nearly 50 per cent of the total mix.

However, we expect sustainability-linked bonds (SLBs) to continue being the fastest-growing category of GSSSB.

While issuance of almost all other types of GSSSB contracted over the past 12 months, SLBs are the only bond type to increase nominally year on year. Total SLB issuance increased to $47.8bn in the first half of 2022 from $40.3bn in the corresponding period last year.

However, SLB issuance is still driven primarily by non-financial corporates. The attractiveness of this class is exemplified by inaugural issuances in large, previously untapped markets.

The flexibility and accessibility of SLBs by a wide range of issuers has also underpinned growth in the instruments.

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In contrast to other types of GSSSB, SLBs are not dependent on dedicating issuance proceeds to defined environmental or social projects.

Instead, an issuer can apply the label to any type of bond that directly links funding costs to achieving predetermined sustainability performance targets. The proceeds could be used for any general corporate purpose.

Given the greater flexibility in use of proceeds, SLBs have the potential to broaden the universe of issuers who can obtain sustainable financing.

Entities unable to issue a use-of-proceeds bond (green, social or sustainability bond) because they do not have sufficient capital expenditures connected to sustainability projects could still tap the sustainable debt market with SLBs.

This includes companies in the consumer discretionary and healthcare sectors. It also includes smaller issuers who might lack the capacity to implement tracking or reporting practices required for use-of-proceeds instruments; issuers at the beginning of their sustainability journeys; and those in transition and sectors such as industrials or materials.

However, SLBs are coming under scrutiny as investors and stakeholders are focusing on the ambition of issuers’ sustainability goals, as well as the incentives embedded in the SLBs to achieve those goals.

Efforts to improve transparency and comparability are welcome.

In June this year, the International Capital Markets Association released publications to increase transparency in the GSSSB market, including an illustrative registry of key performance indicators for SLBs.

Documents like these will continue to encourage potential issuers to consider SLBs as a viable way to demonstrate their commitment to sustainability and for investors to monitor their progress.

There is also substantial room for SLB growth in emerging countries, especially in the Asia-Pacific (Apac). The region accounts for 24 per cent of global GSSSB issuance, but only 8 per cent of global SLB issuance.

In a landmark event in Latin America in March this year, Chile became the first country to issue a sovereign SLB. The $2bn instrument had an order book of more than $8bn, with investors spread across Europe, Asia and the Americas.

Despite Latin America’s relatively small share of total bond issuance, more than 30 per cent of all GSSSB issuance in the region is sustainability-linked.

This indicates pent-up potential for SLBs in both Latin American and Apac regions, which may lead to stronger growth once pressures ease in global credit markets.

Considering GSSSB has not been impervious to pressures on global bond issuance, it is almost certain to fall short of 2021 levels as inflation and interest rates continue to rise.

Low refinancing needs in the near term, rising yields and the increasing odds of recession will continue to weigh on volumes in both the overall bond and GSSSB markets.

We anticipate that issuers across sectors will continue to explore financing opportunities in the GSSSB market owing to investor demand, changing regulation and a desire to align financing needs with sustainability objectives.

Dennis Sugrue is senior director of sustainable finance at S&P Global Ratings, a member of The Gulf Capital Market Association

Updated: October 27, 2022, 4:59 AM