IN a move that is likely to strengthen sustainable capital markets, the ICMA (International Capital Market Association) recently released its Sustainability-Linked Bond Principles (SLBP), that details best practices issuers should consider when crafting such bonds.
With the rapid development of green and social bonds in regions such as Asia over the past several years, the prospect of sustainability-linked bonds is an exciting option for issuers looking to go down the sustainability path.
Unlike green and social bonds which generate proceeds dedicated towards certain projects, sustainability-linked bonds have financial or structural characteristics that can vary depending on whether an issuer has met predefined sustainability objectives. This could mean possible variation of the bond’s coupon rate if targets are made or missed.
While sustainability-linked bonds are still at the early stages, sustainability-linked products have started to take shape in the loan market. Last year for example, issuers such as Australia’s Sydney Airports and Hong Kong’s Swire Properties completed their respective sustainability-linked loans. According to data from Moody’s Investors Service, sustainability-linked loans notched an average quarterly volume of US$34 billion worldwide in 2019.
In ICMA’s sustainability-linked bonds guidelines, the association refers to five core components needed in constructing a sustainability-linked bond such as selection of key performance indicators (KPIs), calibration of sustainability performance targets (SPTs), bond characteristics, reporting and verification.
For KPIs, the ICMA advises that they should be credible and material to the issuer’s core sustainability and business strategy, addressing relevant ESG (environmental, social and governance) challenges facing a particular industry.
With the crafting of SPTs, issuers should take care in choosing a realistic target they are ready to commit to. SPTs should be made in good faith with the issuer disclosing strategic information that may significantly impact the achievement of such targets. To enhance the foundation of the sustainability-linked bond, the ICMA encourages issuers to appoint an external reviewer to confirm the rationale and level of ambition of proposed SPTs.
Issuers should also consider the bond characteristics they are proposing with the ICMA recommending that any variation of a bond’s financial or structural characteristics, such as coupon rate, should be commensurate and meaningful.
Likewise, critical to forming a sustainability-linked bond is consistent reporting from the issuer and verification from an external party on whether SPTs have been met. ICMA says that reporting, for example, should be published at least annually.
Overall, the ICMA’s SLBP are a progressive step in the right direction, giving comfort to issuers looking to embark on their own sustainability path such as Italian multinational energy company Enel S.p.A. The Rome headquartered company turned heads last year when it executed the world’s first sustainability-linked bond raising US$1.5 billion from investors. The bond’s coupon rate is reported to go up if the company misses any environmental targets in the future.