- The more flexible sustainability-linked bonds are a financing tool for companies that still want to take positive steps towards sustainability
- The goals of SLBs can be more general and overarching rather than the bond’s proceeds being tied to the financing of specific projects that create a positive environmental impact
- "Issuing an SLB gives companies the opportunity to look beyond the pure environmental theme at the bigger sustainability picture"
Despite the huge popularity of green bonds, NN Investment Partners believes that their specific environmental focus and use-of-proceeds structure mean they might not be the best option for every issuer as some have insufficient environmental projects to issue a green bond. In its view, there is also a role for other types of sustainable bonds, like the more flexible sustainability-linked bonds (SLBs), as a financing tool for companies that still want to take positive steps towards sustainability.
Analysis by the asset manager indicates that sustainability-linked bonds do not command the equivalent of a green premium (greenium) which is the case for some green bonds. "This shows that there is more scepticism in the market as to the how sustainable SLBs really are", they say.
These bonds have key performance indicators (KPIs) set by the issuers that are aligned with their sustainability strategies. NN IP points out that their goals can be more general and overarching rather than the bond’s proceeds being tied to the financing of specific projects that create a positive environmental impact, which is the case for green bonds. The market for SLBs has grown rapidly from 5 billion dollars in 2019 to over 19 billion in the first half of 2021.
“SLBs offer companies an instrument to tackle sustainable or social issues that are not directly climate-related. Many are not large CO₂ emitters and do not have sufficient environmentally linked financing needs to enable them to issue green bonds. Issuing an SLB gives these companies the opportunity to look beyond the pure environmental theme at the bigger sustainability picture", says Annemieke Coldeweijer, co-lead Portfolio Manager Sustainable Credit at NN IP.
The analysis shows that investors have some degree of scepticism about SLBs because there is less concrete information on how their proceeds will be used and the potential impact they will have. The flexible structure of the KPIs also makes “sustainability washing” easier. To combat this risk, the asset manager recommends investors to consider four key factors when assessing the robustness of a bond’s sustainability KPIs:
Any KPIs related to the climate crisis should be aligned with the company’s carbon neutral target by 2050 (1.5°C scenario). In its opinion, issuers should establish this target and have it verified by an external party, such as the Science Based Target Initiative.
Focus on emission scopes
Climate-related KPIs should focus on the key emission scopes of the issuer. For example, while some companies have more emissions in Scopes 1 and 2 -directly generated by the company or related to its upstream activities, such as its power sources- others, such as automotive manufacturers, have more emissions in Scope 3, which include emissions that are a consequence of a company’s operations but are not directly owned or controlled by it, such as when consumers use its products.
Reflect true business-related sustainability issues
NN IP believes that SLBs should have KPIs that accurately address the crucial sustainability problems that the issuers are facing. Recent examples include healthcare company Novartis, which issued a sustainability-linked bond with KPIs linked to patient access, and food retailer Ahold Delhaize, where the SLB had KPIs linked to food waste.
The KPIs should be well-documented and verified by independent parties, such as Sustainalytics or ISS. Issuers should report on their progress in terms of the KPIs annually and have them audited externally.
Lastly, Coldeweijer highlights that transparency and corporate disclosure are key when it comes to assessing the impact of an SLB and a company’s ESG targets and achievements; but she warns that data and reporting on sustainability is still a challenge for both companies and investors, and although increasing regulatory requirements are improving standards, there is still some way to go.
"This is also why in our bond selection process we do not rely solely on data from the companies themselves or on third-party ESG data sources alone. We carry out our own thorough ESG analysis of the issuer, both qualitatively and quantitatively. This ensures we develop a proprietary view on the ESG/sustainability performance, before investing in any issuer and in any bond", she concludes.