Yoruk Bhceli, Tommy Wilkes

LONDON (Reuters – A record number of companies are offering bonds with penalities attached if the company fails to achieve environmental and social goals. However, there’s a catch – some targets are so soft that they can be pushed off the accelerator.

Because so-called sustainability-linked bonds (SLBs) are in high demand from investors keen to burnish their green credentials, those companies are also rewarded with lower borrowing costs.

    A Reuters analysis of 48 SLBs issued by the 18 biggest borrowers in 2021 showed that nearly half, or 23, included a target which lets them improve at a slower rate than they have done previously.

Italian utility was the first to introduce SLBs. Enel 2019 MI: (Mortgages Interest Rate): Companies pay higher interest rates to investors in the final years of bonds if they do not meet specific environmental, social or governance (ESG), targets.

SLBs are not like the larger green bond market which only funds certain projects. Instead, they focus on the company’s overall goals and don’t restrict the way the money can be spent.

What are you actually accomplishing if the goals and targets aren’t aspirational? Stephen Liberatore is the sustainability portfolio manager at Nuveen. He hasn’t bought any SLBs as he doesn’t believe they incentivise change.

However, other investors have contributed and the issuance of bonds has risen to $91 Billion in 2021 from $8.2 Billion in 2020. Refinitiv data indicates that this is due to investor demand for ESG-related products and for eligibility for European Central Bank bond purchase.

SLBs, like green bonds, are largely unregulated but often adhere to the voluntary principles of the International Capital Market Association, (ICMA), trade organization.

These principles demand that targets be set with ambition, reflect material improvements in the underlying indicators, and are beyond what is usual.

ICMA believes ambition includes comparisons to external benchmarks where feasible, consistency with overall sustainability strategies, and a defined timeline.

Experts, however, say that this is not sufficient to set a standard for ambition.

Michelle Horsfield from Climate Bonds Initiative, who heads climate sustainability standards, stated that although I don’t believe the SLB market is corrupt, “I am worried it might be”

When Reuters reached out to ICMA, it reiterated its principles. It pointed to a different climate financing mechanism.

Managers of money buy bonds that they don’t want to be ambitious because ESG flows are excessive.

Joshua Kendall, responsible investor, stated that only four of the 36 SLBs who were eligible for Insight Investment’s sustainability funds met its highest standards for transparency and ambition.

Daniel Ender (credit analyst, Dutch asset manager ACTIAM) expects all SLB issues to meet their goals.

He said, “We’d love to see more ambition. Then we would concentrate on companies and frameworks that have a greater positive contribution but this is not what’s happening yet.”

SLB issuance https://fingfx.thomsonreuters.com/gfx/mkt/byprjqnjgpe/slb%20chart.PNG

What is BLIND AMBITION?

Reuters looked at the company’s targets, their emissions, and any other pertinent metrics. These data were taken from corporate sustainability frameworks and bond documents. It then compared them with their past sustainability performance.

Enbridge, the Canadian energy pipeline operator (NYSE 🙂 raised $1.8 Billion from two 12-year SLBs. They both include the target of reducing greenhouse gas emissions intensity in ‘Scope 1 and ‘Scope 2 by 35% between 2018 and 2030.

If Enbridge fails, investors will be paid 50 basis points higher in interest each year starting 2030.

Scope 1 emissions refers to direct company operations. Scope 2 emissions relate to power consumption.

Enbridge saw its combined emissions fall 23% in 2019, partly due to divestment from gas assets. Enbridge was well on the road to meeting its goal before bonds were issued.

Additionally, the company had already achieved more than half of its targets to increase ethnic diversity within its workforce and in women on its boards.

Enbridge supported its targets by arguing that its 2030 emission goal was a “significant effort”, and that second-party opinions found them relevant and essential to the company’s business.

ISS, the opinion provider, stated in its opinion, and repeated to Reuters, that there wasn’t enough historical data for ambition against past performance. It did however state Enbridge was ambitious compared to sector peers.

The company also stated that the emission target was not “moderately significant” as 80% of Enbridge’s emissions are derived from its customers.

Enbridge spokesperson stated that the company does not consider these goals to be something it should slow down in order to make good progress toward achieving them.

The pledge of Tesco, a British retailer (OTC:), to reduce emissions by 60% between 2015 and 2025 is another target that doesn’t seem too difficult.

Tesco reached 83% before it launched its first SLB. According to a spokesperson, the target is aligned with global warming keeping at 1.5 degrees Celsius. It was noted that Tesco will make improvements as it nears its targets.

Mexican bottler Femsa, a Mexican retailer, met 88% its goal to grow its electricity consumption from renewable sources by 2025. The bond was issued for a seven year term. The bond includes an ambitious goal to reduce waste going to landfill.

Femsa spokeswoman, while acknowledging that the target was percentage-based. She stated that calculations using percentages don’t account for Femsa’s growth, Latin American renewable energy challenges, or different energy requirements.

Femsa was 68% closer to the goal according to alternative calculations made using absolute consumption levels.

MATTER OF OPINION

Second-party opinion providers (SPOs), who are responsible for broader assessments of SLB frameworks, usually review targets.

These aren’t enough for some investors, so they do their analysis. ISS is an opinion provider that provides opinions. They are not qualified to evaluate bonds.

Viola Lutz Head of ISS ESG Climate Solutions said that SPOs are not “a stamp on sustainability of the bond”, but an independent, transparent opinion about its key features and sustainability.

In cases such as Tesco and Femsa where companies were compared to peers, by using industry benchmarks or aligning with 1.5 degrees, opinions providers determined that there was enough ambition for even targets without a company’s track records.

According to them, they can be clear when insufficient data is available to evaluate ambition. According to them, companies should base their targets on the latest year of verifiable data. However, this is not important for science-based targets.

The penalties are weak as they add 0.125% to 0.50% per year in interest over the bonds’ final years.

James Rich of Aegon Asset Management stated, “Companies have a perverse incentive to promise a bunch of things they don’t really care about.”

Rich calculates that strong demand results in borrowers saving 5-10 basis point per year on interest costs relative traditional bonds.

SLBs can be used to help companies secure financing at their lowest cost. JBS in Brazil, the U.S. branch of JBS meat processing company, issued an SLB last week for its lowest borrowing costs.

Others believe that SLBs are on a good start, and their structures are improving. Some recent bonds use 2020 baselines instead of 2015.

Saida Eberstedt said, “It is not about the goal.” Schroders (LON)’s head of sustainable credit. He believes that SLBs promote better corporate behavior and deeper engagement.

She said, “If the companies did not issue the SLBs and met the targets then nobody would know.”

Eggersted is not convinced retailer H&M’s target to increase recycled materials usage is the right one, but said its SLB arms investors with information to encourage change at rivals.

Kim Hellström, H&M’s Strategy Lead Climate, said its target was “industry leading” and that recycling was growing fast from “very low” levels a few years ago.