Sustainability-linked bonds (SLBs) are linked to the issuer’s achievement of climate or broader sustainability goals, such as through a covenant linking the coupon of the bond. In these bonds, the progress, or lack thereof, toward achieving the predefined key performance indicators (KPIs) can impact the pricing structure of the instrument’s coupon. Unlike other sustainable bonds (i.e., green, social, blue, and sustainability bonds), SLBs do not have use-of-proceeds criteria, such as financing particular projects, and can be used for the general purposes of firm or government operations that have explicit sustainability targets. Instead of the criteria, each KPI is linked to a certain trigger event that has the potential to modify the pricing structure of the bond if the KPI is not achieved by a predetermined date. The coupon rate may increase, for example, if the issuer does not meet a predetermined agreed target.
SLBs have typically been used by corporations to further their overall sustainability strategies or to deliver on specific KPIs; users include issuers in banking, retail, consumer products, and business and consumer services. Thus, these bonds can encourage companies (or sovereign countries) to make sustainability commitments, particularly through aligning to the United Nations Sustainable Development Goals or the Paris Agreement.
Most of the SLBs’ climate-related targets to date have focused on mitigation; however, firms or governments could use financing issued through these bonds to undertake adaptation projects, such as improving flood protection. The addition of impact metrics that capture climate resilience improvements could allow firms or governments to utilize SLBs and increase financing for adaptation outcomes.
Current or potential adaptation-relevant sector application:
- ecological services and management – forest management (including afforestation and reforestation); wetlands; ecosystem and biodiversity protection, conservation, and enhancement;
- water supply (infrastructure) – water management;
- energy infrastructure – energy generation (including renewables);
- transport infrastructure;
- other built environment and infrastructure – urban development; and
- industry and manufacturing.
Additional insights:
- This is an emerging instrument that is growing fast in the corporate debt market. The first corporate SLBwas launched by ENEL (an Italian power utility company) in 2019.
- SLBs make up a small portion of the sustainable debt market, representing only 4% of the issuances as of July 2023.
- SLBs have mainly been issued by non-financial corporations based in Europe.
- The world’s first sovereign SLBs were issued by Chile and Uruguay in 2022. Chile’s KPIs were linked to climate mitigation targets, and Uruguay included KPIs linked to their nationally determined contribution goals for greenhouse gas emissions and maintenance of native forest areas.
- The OECD (2023) reports that SLBs have potential for developing countries because they typically have lower costs and require less operational set-up than bonds that require use-of-proceeds tracking.
Considerations for issuing SLBs:
- SLBs could be used on any social or environmental KPI. Examples include a reduction in the number of people affected by saltwater intrusion, the area of mangrove forest retained, or the number of cooling centres established. Most corporations have adopted climate-related KPIs linked to greenhouse gas emissions because of the ability that gives them to set measurable and quantifiable targets.
- Bonds need a plan to meet the KPIs.
- Bonds are not appropriate for all borrowers/issuers, especially in countries that may not be able to take on additional debt.
- Guarantees may be needed to increase investors’ confidence in bonds issued in developing countries.
Adapted from the following sources:
Godemer, M. (2023, July 19). Sustainability-linked bonds have long road to drive impact. BloombergNEF. https://about.bnef.com/blog/sustainability-linked-bonds-have-long-road-to-drive-impact/
International Capital Market Association. (2020, June). Sustainability-linked bond principles (SLBP). https://www.icmagroup.org/sustainable-finance/the-principles-guidelines-and-handbooks/sustainability-linked-bond-principles-slbp/
Organisation for Economic Co-operation and Development. (2023). Green, social, sustainability and sustainability-linked bonds in developing countries: The case for increased donor co-ordination. OECD Publishing. https://www.oecd.org/dac/green-social-sustainability-bonds-developing-countries-donor-co-ordination.pdf
S&P Global. (2022). Global sustainable bond issuance to surpass $1.5 trillion in 2022. https://www.spglobal.com/ratings/en/research/articles/220207-global-sustainable-bond-issuance-to-surpass-1-5-trillion-in-2022-12262243