Labelled market still evolving as ambition remains the order of the day
Transition and sustainability-linked bonds have offered early potential to support the aspects of economic transition with the greatest degree of additionality and impact. But issuance has slowed after a promising start, in particular due to enhanced scrutiny of transaction structures’ ambition. Market leaders gathered in Amsterdam in June to path a road forward.
Helen Craig Head of Operations KANGANEWS
The labelled bond market as a whole is close to another issuance milestone. According to International Capital Market Association (ICMA) and S&P Global Ratings data, total green, social, sustainability and sustainability-linked (GSSS) issuance volume in 2023 was similar to that of 2022 – at around US$930 billion equivalent. S&P predicts it may rise in 2024 to as much as US$1.1 trillion, noting that macroeconomic factors including central banks nearing the end of their rate hike cycles may have a dampening effect.
In the immediate future, though, the clear consensus is that green bonds will continue to dominate the GSSS market, driven by increased demand for environmental projects across geographies. The current year seems likely to follow recent trends: in 2023, green bonds comprised 59 per cent of GSSS issuance globally, edging ahead of the 56 per cent green-bond component of 2022 supply.
According to Climate Bonds Initiative (CBI) data, sustainability-linked bond (SLB) volume was a disappointing US$21.4 billion equivalent in 2023. SLBs’ contribution to the GSSS total actually fell between 2022 and 2023, to 7 per cent from 8 per cent. The signs are that 2024 will not deliver a notable change in dynamics.
Speakers at ICMA’s 10th Annual Conference of the Principles, held in Amsterdam in June, discussed how the debt market can deliver products and, more importantly, volume of funds to support environmental transition. According to Bryan Pascoe, chief executive at ICMA, while the labelled bond market has been relatively constructive during the last decade there has been a change in tone of late.
Speaking at the conference, Pascoe said: “We have witnessed a plateau in the past 12-18 months, with SLBs the most affected. We are mindful of the opportunities that ICMA has to bring positive influence via harmonisation and greater consistency in transition finance and SLBs.”
One reason for the changing tone is the impact of regulation, which has caused many potential issuers and investors to shy away from making claims about more complex sustainability concepts like transition – which inevitably involves financing businesses and projects that are not yet at their final state of emissions reduction. There is not yet a consensus about whether this regulatory oversight will eventually help or hinder the ongoing growth of the labelled asset class (see box on p42).
Ultimately, though, the main issue that has stalled the SLB market is lack of agreement about what constitutes appropriately ambitious targets for issuance, and resulting lacklustre support from the buy side. The narrative in 2024 is that many issuers are hesitating when it comes to transition bonds and SLBs – but they are not ready to admit defeat yet.
Unlike green, social and sustainability bonds – where proceeds are ringfenced to finance or refinance specific projects – SLBs and transition bonds support climate transition goals. They tend to be geared toward issuers in hard-to-abate sectors and if there are eligible projects, they may therefore not always be green. But they should still aim at supporting climate transition.
Lars Eibeholm, head of sustainable debt capital markets at SEB, says companies are pausing for various reasons. “The issuer will be blamed if the targets or KPIs are deemed ‘wrong’ or insufficiently strict. It is also important first to ascertain at borrower level whether it is ready to deliver. We also need to recognise issuer performance as a journey to a better place.”
The widespread fear of missing targets has been made real by Enel. Since the Italian utility launched the world’s first SLB in 2019, it has been held up as the poster child for the instrument. However, Enel announced in April this year that it would miss the 2023 emissions intensity target on several of its SLBs, leading to a coupon step-up.
On the other hand, some market participants say Enel’s experience demonstrates that the SLB structure is actually working exactly as it was designed to do. Targets are meant to be ambitious, and ambition demands the possibility that they not be achieved. The market response appears to have been constructive, too.
“Enel has missed targets but its secondary spreads have responded positively,” Alban de Faÿ, head of ESG and green fixed income processes at Amundi and vice chair of the executive committee of the principles, told delegates. In the wake of Enel’s missed target announcement there was a swift pricing reaction on the affected bonds: according to a report by the Anthropocene Fixed Income Institute (AFII), they outperformed by an average of 59 basis points in the following week.
Isabelle Laurent, deputy treasurer at European Bank for Reconstruction and Development and chair of the executive committee of the Principles, also views the missed target experience as supportive of positive market development. “A bit like identifying what is ‘green or green enough’, the other thing that has struck me about SLBs this year is a need to identify what is ‘ambitious or ambitious enough’,” she said. “Missed targets speak to the fact that the products are robust, ambitious and not business as usual.”
Enel has continually demonstrated commitment to the structure by issuing multiple SLBs since its debut, adding a US$1.25 billion five- and US$750 million 10-year SLB on 19 June – even after it had missed targets. According to the AFII report, the bonds printed 5-8 basis points through the issuer’s secondary curve on a day when the average new-issue premium was around 4 basis points.
Speakers at the ICMA conference insisted that the Enel episode is largely positive for SLB evolution. For example, de Faÿ suggests the fact that there is now a track record that didn’t exist either in 2019, when the first SLB was issued, or in 2020, when the SLB Principles were created, helps drive the executive committee to keep up with market development as well as to correct and improve existing processes and guidelines.
“We have made a few adjustments to the SLB Principles including one new definition: to reinforce the KPIs, which now have to be the most material for the issuer,” de Faÿ revealed. “This will ensure alignment with the overall strategy of the company. We have also further developed the KPI registry to include biodiversity, the circular economy and KPIs applying to sovereign issuers.”
GREATER AMBITION
Speakers at the Principles conference were therefore optimistic that confidence about SLBs and, potentially, transition bonds will grow, while issuance of these instruments will pick up pace once again. To fill the gap in the meantime, they expect green bonds to continue to evolve to tighten the focus on additionality and impact.
While green bonds have so far tended to focus on the least controversial areas – like green energy, sustainable transport and the energy efficiency of buildings – market participants insist there are still plenty of pathways and assets to explore. For example, momentum is building on the concept of a circular approach to the economy that eliminates waste and pollution, increases a product’s lifespan by recycling materials back into use and regenerates nature.
“To move to the next phase, we need to look at the full environmental universe,” Eila Kreivi, chief sustainable finance adviser at European Investment Bank, commented. “It would be good to see a green bond that is focused on the circular economy or on plastic pollution.”
On the other hand, transition finance still lacks a universally agreed definition and it does not have widely accepted transition-bond principles. Even so, the Japanese government brought the world’s first sovereign climate transition bond, in multiple tranches, in February 2024. It has plans to issue up to ¥20 trillion (US$120 billion) of transition bonds over the next decade.
Izuru Kobayashi, deputy director general for environmental affairs at Japan’s Ministry of Economy, Trade and Industry, explained to conference delegates why Japan elected to take a leadership role in the transition-bond space.
“We wanted to increase awareness of transition finance and to demonstrate leadership for Japanese companies that want to issue their own transition bonds,” Kobayashi said. “Our aim is to provide tools for these companies to develop their own transition plans. For example, the government has developed roadmaps for the use of hydrogen and ammonia technologies with a proportion of the proceeds from the sovereign bond being used in the development of these transition technologies.”
ICMA continues to respond to requirements from the market and to issue new guidelines where appropriate. Angela Brusas, director, funding and investor relations at Nordic Investment Bank and member of the executive committee of the Principles, explained: “This is why we convened a taskforce in 2023 to look into the possibility of use-of-proceeds bonds financing SLLs [sustainability-linked loans]. Lending banks and multilateral development banks play an important role at the interface between financial markets and the real economy, and we can support them by offering different kinds of credit products.”
She continued: “There is substantial volume of SLLs and, with new guidelines, we are aiming to help financial institutions use their portfolios of SLLs as well as offering institutional investors the opportunity to support companies to transition. In the long run, we believe this will help support further development of the SLL market as well as enhance transparency and credibility overall.”
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Regulation reflection
Speakers at the International Capital Market Association’s Conference of the Principles say that while the inception of the sustainable finance market was driven by investors seeking to address their anxiety about climate change, regulation was the prerequisite needed to drive the market forward. The five-year anniversary of the first regulatory proposals provided a juncture at which to reflect on progress.
Sean Kidney, Climate Bonds Initiative’s chief executive, believes the extent to which regulation has turbocharged markets is extraordinary. “The soft touch of central banks has also been incredibly powerful in changing the economic normality of climate change,” he added. “Central banks have normalised the idea that financial institutions need to address climate and, because of regulation, banks have teams and are now generating product as well as disclosure.”
However, he also acknowledged that the green-bond market is a “bit of a mess at the moment” precisely because of the requirements of the European green bond standard. This is an EU-wide voluntary standard that uses the EU taxonomy to define green economic activity and to ensure transparency in line with market best practice. The overall objectives are to open up new opportunities for issuers and investors, and to tackle greenwashing. “We know we have to improve the EU green bond standard and at this particular juncture there is strong appetite among industry to do so”, Kidney told conference delegates.
In part this is because of growing concern about regulatory scrutiny of claims about sustainable behaviour. For instance, the UK Financial Conduct Authority opened its first-ever climate investigation in June. And there has been much coverage of the Australian Securities and Investment Commission’s first forays into climate-related disciplinary action.
The expectation is that there is more to come. Indeed, there is some dissatisfaction with the pace of activity. Ulf Erlandsson, chief executive at Anthropocene Fixed Income Institute, said the small number of sanctioned measures in relation to climate is “simply not good enough” and suggested it demonstrates a “lack of bandwidth” by regulators.
He added: “It is great, sometimes, to have regulation. But we need sanctions and capacity to judge if something is right or wrong. There also needs to be a place for concerned investors to go to discuss issues with companies, for example on greenwashing, and we also need to see the subsequent effects of these discussions.”
The fear of greenwashing is front of mind for every chief executive in the 46 portfolio companies overseen by Denise Odaro, managing director and head of ESG and sustainability at PAI Partners. “They are on the cusp of being greenhushed,” she said. “The role of the underwriter is critical. We need the market to come together to decide on best practice. The issuer’s, bank’s and investor’s reputation is at stake. None of us know it all but best practice is at the heart of what we’re trying to achieve.”
Helena Vines Fiestas, commissioner at the Spanish Financial Markets Authority and chair of the EU Platform on Sustainable Finance, added that even though the EU has not yet seen many sanctions it has received a number of questions from nationally competent authorities on reporting, including requests to adjust reporting to bring it in line with regulatory requirements. Although challenges remain, Vines Fiestas also insisted there is proof that European regulation is moving the market in the right direction.
For example, in relation to the concept of “do no significant harm” Vines Fiestas said the commission is working hard to adapt to users’ needs to make the environment more functional.
Specifically, she noted that €440 billion (US$471.2 billion) has been invested in taxonomy-aligned activities or in transforming business models to achieve alignment with the EU taxonomy since 2022. Based on two years of data and reporting on climate, covering 1,700 publicly listed European companies, revenue and capex alignment is higher than had been expected at an average of 20 per cent.
“Equally as encouraging is the fact that 600 of the publicly listed companies covered that cannot currently align their capex are setting targets to do so and, in line with something that for a long time we have been advocating for, they are linking these with their transition plans,” Vines Fiestas continued. “Capex alignment and targets become essential elements of transition and financial planning. In addition, companies that are better aligned with the taxonomy have outperformed over the past five years.”