The rapidly growing sustainability-linked bond (SLB) market, and SLB issuers would benefit from the incorporation of more ambitious performance metrics and sustainability goals, according to fixed income investment manager PIMCO.
Sustainability-linked debt is one of the fastest growing areas of sustainable finance, with attributes including interest payments tied to an issuer’s achievement of specific sustainability targets. Corporate interest in sustainability-linked loans has grown rapidly, as the financing provides flexibility to use proceeds for general corporate purposes, while with instruments such as green bonds, raised funds can only be allocated to specific categories of green projects.
In a post by PIMCO ESG Research Analyst Samuel Mary, Portfolio Manager Ketish Pothalingam and ESG Research Analyst Juan Rojas, the fixed income manager outlined the drivers of the dramatic growth in SLBs, including investor interest in aligning their financial goals with sustainability benchmarks, and the facilitation of this growth, with the 2020 release by the International Capital Market Association (ICMA) of voluntary guidelines – the Sustainability-Linked Bond Principles – aimed at improving the transparency and overall integrity of the SLB market.
The post highlights the ability to strengthen the credibility of the SLB market, pointing out that “debatable practices” remain, that “continue to pose challenges for investors.” The authors state, for example, that “in many cases, deals have included ESG metrics only for direct greenhouse gas emissions even if the vast majority of the issuer’s overall emissions are indirect and other sustainability metrics, such as water, pollution, waste, safety, or health, are more relevant for the issuer’s industry.”
The post offers a number of suggestions to improve SLB structures, including introducing shorter trigger dates to evaluate if key performance indicator (KPI) targets have been met, building milestones into sustainability performance targets (SBTs) and providing legal documentation to demonstrate progress, and providing external verification of the historical performance of the KPIs, calculation methods and data quality. Recommendations also include following practices in line with typical bond covenants, including the use of credible and ambitious targets, the inclusion of material and relevant metrics.
The authors wrote:
“We believe SLBs sit well alongside the well-established use-of-proceeds markets, and we will continue to evaluate new deals based on our proprietary evaluation framework for ESG-labeled debt while partnering with issuers to support best practices. Most encouraging for us is the increasingly wide set of issuers choosing to issue SLBs. While clear progress has taken place, the room for improvement is undeniable.”
Click here to view the post.