Meanwhile, the launch of SLBPs is a significant development for the GBP SBP, which is moving for the first time to provide guiding principles to bond instruments which do not have specific use of proceeds (UOP). Instead of identifying specific assets which are funded by a green, social or sustainability (GSS) bond, an SLB requires a wholistic assessment of an issuer’s overall sustainability credentials and its plans to improve them over time. The instrument has been used by only a few borrowers, including Sydney Airport, but has potential to encompass a much broader range of issuers than UOP instruments.

Tanguy Claquin, member of the GBP executive committee and head of sustainable banking at Crédit Agricole in Paris, says: “One of the key messages here is that the GBP SBP as a forum is asserting itself as the backbone of all sustainable fixed-income markets, looking at all instruments that are dealing with sustainability in fixed-income markets – beyond UOP bonds.”

The COVID-19 pandemic has invigorated focus on the potential use of social bonds, and there has been record issuance of the instrument in 2020. However, the social bond working group has been sharpening the guidelines around social bond issuance since the GBP SBP’s AGM in June last year.

Post the 2019 AGM, the social bond working group identified five areas to focus on in the coming year, to accelerate the growth of the social bond market. These were to provide more guidance on impact measurement and reporting, to create case studies to illustrate eligible UOP, to review and update the mapping of SBPs to the UN Sustainable Development Goals, to review the SBPs to ensure they keep up with market evolution, and to create an investor survey which would canvass investor views on and requirements for social bond investments.

The key changes in the updated SBPs are a definition of what constitutes a social issue, expanded examples of project categories which are used to identify UOPs and adding more context on target populations. These were all in train prior to the COVID-19 pandemic, but with the onset of the global crisis early in 2020, the penny appears to have dropped with many market participants as to the purpose and potential use of social bonds.

Denise Odaro, member of the GBP executive committee and head of investor relations at International Finance Corporation in Washington, says the pandemic has helped cement the concept that the general populace can be an option for a target population, rather than a social bond needing to specifically target a population subset.

“While you may have a target population which could be people living at the base of the pyramid, minorities or marginalised populations, there are instances where you do not need to have a subset of the population because it is such an endemic social issue that it affects everyone. While no-one knew it was to come, the COVID-19 pandemic in itself is a testimony to that,” Odaro explains.

Social bonds have obvious use during a pandemic, to fund solutions in areas such as health and sanitation. But the updated SBPs extend the instrument’s application to the recovery as well. For example, the social project category of employment generation has been expanded to include programmes designed to prevent or alleviate unemployment stemming from socio-economic crises.

Key differentiators of an SLB are it’s forward-looking character and the focus on the wholistic vision of an issuer’s strategy.

The new SLBPs define an SLB as any type of bond instrument for which the financial and/or structural characteristics can vary depending on whether the issuer achieves predefined sustainability/ESG objectives. In this sense, SLBs are a forward-looking, performance-based instrument, with issuers committing explicitly to future improvements in sustainability outcomes within a predefined timeline.

The launch of the SLBPs – which are voluntary process guidelines that outline best practices – is an acknowledgement by the GBP SBP of what is the vanguard of sustainability finance in debt markets. Sustainability-linked bonds (SLBs) were inspired by sustainability-linked loans (SLLs), which incentivise borrowers to meet environmental, social and governance (ESG) targets without having to identify specific UOP for the funding.

This opens sustainability-linked funding to any borrower that can prove it has legitimate plans to meet ESG targets, rather than just those that have sufficient and appropriate capex for a UOP GSS bond or loan deal.

SLLs have proven immensely popular with corporates and have grown rapidly in the last two years. Issuance of SLBs has been scant, with just a couple of deals executed in late 2019 and early 2020, but interest in the product is great. Acknowledging this, GBP SBP set up a taskforce in October 2019, which was converted to a working group in January 2020.

The working group comprised more than 40 organisations and several hundred people. Marilyn Ceci, member of the GBP executive committee and head of green bonds at J.P. Morgan in New York, says a key question to address was why SLBPs are important and how they will further enhance the development and growth of SLBs.

Ceci comments: “The green bond market, which has been very successful to date, has left out a certain segment of the market. For issuers that have enough capex to issue UOP instruments, SLBs will present an opportunity to broaden and complement existing UOP instruments. Green, social and sustainability bonds are instruments that commit capital to specific projects, while with SLBs the idea is to commit to a particular outcome, which is quite different.”

Lars Eibeholm, chair of the GBP SBP executive committee and head of treasury and sustainability at Nordic Investment Bank in Helsinki, adds that potential issuers of SLBs should not see the lack of identifying specific UOP as meaning the targets for SLBs will be easy to meet. “The requirements for issuing an SLB are there to ensure that integrity is maintained and issuers remain transparent. This is exactly what these principles are trying to achieve – to make sure that issuers are not taking a shortcut with an SLB.”

The SLBPs have been drafted with five core principles, designed to ensure the ambition and integrity in SLBs. These are the selection of key performance indicators (KPIs), calibration of sustainability performance targets (SPTs) to assess the KPIs, bond characteristics, reporting, and verification.

Orith Azoulay, member of the GBP SBP executive committee and global head of green and sustainable finance at Natixis in Paris, says KPIs need to be relevant, core and material to the issuer’s overall business, they need to be measurable or quantifiable, externally verifiable and able to be benchmarked as much as possible using an external reference.

With regard to calibration of SPTs, Azoulay says this is a mixture of recommendations around what ambitious means for a target, and how targets should be disclosed to investors. She comments: “We tried to incorporate a lot of comments from the working group members to set some framework around the targets, which need to present a material improvement beyond business as usual for the issuer on each KPI. Where possible, it needs to be compared to a benchmark or external reference, will have to be consistent with the overall ESG strategy of the issuer, and will need to be determined on a predefined timeline set before or concurrently with issuance of the bond.”

Reporting includes both pre- and post-issuance reporting. Azoulay says: “This involves the transparency towards investors on a regular basis – at least annually – on where the issuer stands on its various KPIs and of course the verification assurance report relative to the targets. It encompasses any information that will enable investors to monitor the level of ambition of the SPTs.” To help issuers, integrated into the principles is a transparency and disclosure checklist.

Verification encompasses the required independent and external verification of the issuer’s performance against each target and KPI by a qualified external reviewer – which needs to be made publicly available. Azoulay comments: “This is considered a necessary element of the SLBPs. When it comes to pre-issuance external review – what we usually call a second-party opinion – it hasn’t been considered as necessary but it is recommended to address both compliance with the five core principles as well as the level of ambition of the targets.”

The bond characteristics component refers to the financial or structural characteristics of an SLB, which GBP SBP says should vary depending on whether or not the KPIs reach the SPTs. The variation must be commensurate and meaningful relative to the issuer’s original bond financial characteristics, according to Azoulay. She comments: “This is a cornerstone of this instrument.” The most common example of such a variation is the coupon, which could increase if targets are missed or decrease if they are achieved.

Sydney Airport’s US private placement SLB was the world’s first to have two-way variation in its coupon. Enel, the world’s first SLB issuer, only included a possible pricing increase in its characteristics. Ceci says though, that the Enel bonds issued last year would meet the criteria of the SLBPs.

The SLBPs state that it is possible to consider the variation of other financial or structural characteristics in an SLB, but the GBP SBP does not give any examples, expecting these to come about through natural market development and innovation.

SLBs are intended to be a financing tool borrowers and investors can use to incentivise the transition to a more sustainable economy. GBP SBP set up the SLB working group alongside the Climate Transition Finance (CTF) working group which is looking more broadly at transition finance tools, such as transition bonds.

Transition bonds are a UOP instrument, more like a green or social bond in character than a SLB.

The establishment of SLBPs and not transition bond principles should not be inferred as a bias from SBP GBP towards SLBs for the future trajectory of the market, though. According to Azoulay, the SLBPs will be complementary to the work of the CTF working group.

The CTF working group’s remit was much wider than that of the SLB working group. Its aim, first and foremost, is to address the definition for transition and the types of financing that could be called transition, rather than to come up with principles, Azoulay says.

She adds: “SLBPs will be useful food for thought for CTF work. The next step on our end is to work closely with the CTF working group to see how the SLBPs can help envision one of the ways a transition can be funded.”

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