New Guide Calls for SLB Simplicity
Think tank’s handbook looks to tackle investor confusion over sustainability-linked bonds.
The Anthropocene Fixed Income Institute (AFII) has addressed the need for simplicity around sustainability-linked bonds (SLBs), aiming to assist investors in capitalising on their full potential.
The non-profit recently released a handbook on sustainability-linked bonds to guide practitioners in their understanding of SLBs and help scale the market for these instruments.
What sets SLBs apart is that their issuance proceeds are not ring-fenced to green or sustainable purposes and can be used for general corporate or other purposes. According to the AFII, they hold the potential of directing “billions of dollars” into the decarbonisation of the global economy, and could enable companies and countries to commit to and finance ambitious transition plans.
“SLBs are quite interesting and offer a compelling structure,” Ulf Erlandsson, CEO and Founder of AFII, told ESG Investor. “However, what we’ve seen is there’s been a lot of confusion about the instrument and it’s perhaps not been theoretically well-founded.”
Although investors see the structural potential of the instrument, there has been some frustration especially with older SLB instruments – which Erlandsson said were challenging to price and “lacked ambitious targets”.
Similarly to green bonds, SLBs have also been criticised for acting as a potential ‘platform for greenwashing‘, with their proceeds sometimes not being used for sustainable causes.
Nevertheless, the flexibility they afford has been welcomed in some regions – particularly in developing markets.
“We want simpler and more robust sustainability targets, and a rejig of the market to that simpler place,” said Erlandsson. “We are hearing lots of discussions around various SLBs structures now, and we hope our text can guide those towards easier structures that are more financially material.”
New frontiers
Although sovereigns first entered the SLB market in 2022, such bonds have been issued by only two nations to date: Chile and Uruguay. Both SLBs, issued in March and October 2022 respectively, had KPIs in line with the countries’ Paris-aligned nationally determined contribution.
In June last year, Chile issued a further SLB with a gender-focused KPI – the first sovereign bond to incorporate social targets, and also the first one to be euro-denominated. South Africa is reportedly also mulling the issuance of an SLB, perhaps later this year, and could well develop its own SLB framework.
“One of the advantages with sovereign issuance is that it contains lots of data – especially when it comes to climate and decarbonisation,” Erlandsson said. “There is also the sheer volume of bonds that sovereigns can issue.”
Erlandsson suggest that SLBs could expand beyond developing economies and could hold benefits for developed markets. The think tank has made several proposals to that effect. Its guide also highlights the potential that exists in combining SLB and blended finance solutions.
“Looking at some of the sovereign green bond issuers in Europe, the SLB structure might be more compelling for investors than green bonds,” Erlandsson added. “There’s a desperate need for private capital in developing and frontier markets. If you can combine the SLB structure with credit enhancement, some interesting iterations could be achieved.”
Navigating challenges
As of November 2023, the global SLB market represented US$279 billion, totalling 768 bonds from 469 issuers. However, a report published last month by the Association for Financial Markets in Europe stated European SLBs suffered a 34% year-on-year decrease to €7.8 billion (US$8.5 billion) in Q1 this year.
Italian energy utility Enel having issued the first-ever SLB in September 2019. The country is also the single biggest SLB issuer, with 30 of them representing a total US$31.1 billion. The market peaked in 2021, largely driven by Enel’s €3.25 billion SLB, issued in June that year. Italian issuers supplied €5.1 billion in SLBs in Q1 2024, leading the EU market.
Last month, Enel missed the sustainability targets set in 2023 for a US$11 billion SLBs. This is due to cost the firm an an additional €83 million in interest payments.
Meanwhile, Italian oil company Eni’s €1 billion SLB and €3 billion sustainability-linked loan worth recently saw Barclays being accused of greenwashing by environmental groups after helping to arrange their financing.
“The greatest potential for SLBs is with companies that are considered ‘dirty’ today: that’s where the biggest change can be in terms of carbon reductions,” Erlandsson explained. “I’m not saying we’re there yet, but [SLBs] are at least a vehicle that enables you to sit down with dirty companies and discuss reasonable targets, and what investors can contribute if those targets are hit.”
This week, a report from Pictet Asset Management flagged SLBs as being popular among corporate issuers, citing Brazilian pulp and paper company Klab as an entity that has issued one with sustainable performance targets linked to nature and biodiversity goals.
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