Sustainability-linked  bonds (SLBs) play a crucial role in unlocking the power of the largest pool of global capital – fixed income – to drive climate transition.

The Anthropocene Fixed Income Institute (AFII), a non-profit organization providing research and portfolio management tools for fixed income investors and issuers, has published a guide on SLBs “to equip market participants with the knowledge to identify and invest in ambitious SLBs that offer true financial and sustainability impact”.

“Sustainability-Linked Bond Handbook: A practioner’s guide”, lead-authored by AFII founder and chief executive officer Ulf Erlandsson and Josephine Richardson, the institute’s managing director and head of research, includes over 40 detailed case studies, providing readers with a solid foundation of real-world applications and evidence-based outcomes.

“A central theme of the handbook is the strategic use of pricing mechanisms to design ambitious SLBs,” says Richardson. “Instruments designed this way can attract a broad spectrum of investors while also encouraging issuers to set stretch targets that increase their sustainability impact.”

“The handbook also includes guidance on the various ways in which SLBs can be deployed in fixed income strategies, from pure alpha generation to sustainability risk hedging,” she adds.

The book aims to show how SLBs can incentivize bond issuers to meet ambitious climate targets and achieve a lower cost-of-capital if they are structured correctly. At the same time, investors who believe that transitioning companies yield better returns or are lower risk, can position for this credibly through SLBs, the AFII says.

Several chapters of the book focus on the option pricing model, which seeks to establish a level playing field between investors and issuers. Basically, the model holds that an issuer who commits to pay a higher coupon on a bond due to some condition, should be paid an option premium, which in turn translates into a lower initial, fixed coupon.

“Some SLBs have been structured poorly, some well, and through more than 40 case studies we endeavour to illustrate which factors differentiate them,” the authors say.