The Great Labelled Bond Debate
Sarah Peasey, Head of Europe ESG Investing at Neuberger Berman, discusses climate-focused investor engagement with labelled and unlabelled debt issuers.
The labelled bond market – including green and social bonds – has grown rapidly in recent years, reaching US$5.1 trillion in the first half of 2024, or 4.2% of global debt issuance, according to a recent Climate Bonds Initiative report. Meanwhile, issuances rebounded by 7% to US$554 billion.
In contrast, sustainability-linked bond (SLB) volumes dropped 45% to US$4.6 billion year-on-year.
Sarah Peasey, Head of Europe ESG Investing at investment management firm Neuberger Berman and Co-chair of the Institutional Investors Group on Climate Change’s (IIGCC) Bondholder Stewardship working group, highlighted several challenges related to the alignment of labelled bonds with the net zero transition and other sustainability outcomes.
These included long look-back periods, when companies can include assets/earlier disbursements in the green bond reporting for longer than two years; a reliance on refinancing existing project rather than financing new ones, including in the case of achieved or nearly-there targets; and targets coming before first-call options – a particular pet peeve for Peasey.
Generally, many labelled bonds “lack ambition”, she told ESG Investor – such as a coupon step-ups in sustainability-linked bonds (SLB) that aren’t commensurate with company targets, or SLBs that have a shorter duration than the project they finance.
“Any insight provided on future issuances and how the SLB is going to refinance down the line is more progressive,” she said.
From a net zero perspective, the overarching problem stems from a fundamental disconnect between the use of proceeds and the transition plan within the corporate strategy, Peasey argued.
Regulatory impact
Peasey attributed the decrease in labelled bond issuance to issuer’s increasing adoption of voluntary sustainable finance frameworks.
“There is greater investor awareness of what good looks like,” she said.
On the positive side, this means that SLBs coming to market now meet a higher standard – with a quality likely to keep improving following the introduction of the EU Green Bond Standard (EUGBS) in 2025.
Many companies have approached Neuberger Berman to gauge its appetite in the event they decide to come to market with an EUGBS issuance, according to Peasey.
“I think this indicates a fatigue in trying to constantly meet evolving standards,” she said. “Equally, it reflects escalating investor expectations.”
However, Peasey doubts that many companies will issue under EUGBS. “We could see a positive flow into bonds among companies that still issue – but not as EU green bonds,” she added. “Coming to market with a labelled bond has meant that disclosure has improved – which is good news for investors, as it provides insights that we weren’t able to access before.” Increased transparency is a sure sign of a maturing market.
This has also strengthened investor dialogue, which in turn has opened up an information channel – such as bond roadshows or reverse inquiries – whether from a bank or directly from a company – asking for investor input into labelled bond framework expectations.
But investors should still have their own processes around investing in sustainable bonds, recommended Peasey.
“[Neuberger Berman] implemented a labelled bond checklist around three years ago, which incorporates the likes of the International Capital Market Association’s Green Bond Principles as well,” she said. “It’s a fundamental part of our credit analysis, as we need to take an issuer-centric approach.”
Bondholder stewardship
The investment management firm has embedded IIGCC guidance on listed-equity and corporate fixed-income climate investments.
“The idea is to look beyond the label to the net zero credentials of the company as a whole,” Peasey explained. “This will create consistency when engaging with each company, as well as when looking at labelled or unlabelled debt, as companies will have multiple bonds across the debt stack.”
Having a consistent method in place is important – even before the bond is issued, she argued. “Investors should be thinking about bondholder stewardship before investing,” she added, echoing the IIGCC’s recent guidance on engaging labelled debt.
Peasey strongly argued against the commonly held belief that stewardship can only be performed for equity assets.
“Bondholder impact is on the rise and is becoming more powerful, particularly when it comes to the energy transition,” she said. “This is because of the importance that fixed-income capital will play in driving the transition – the fixed-income markets dwarf the equity markets in terms of size.”
Bondholder stewardship has a role at all three stages of a bond’s lifespan, Peasey argued: pre-issuance, during the holding period, and at refinancing.
“Engaging pre- and post-issuance are of equal importance, however during the pre-issuance period, it’s easier to have an impact on the bond framework, commitments, key performance indicators (KPIs) and targets set by a company,” she said. “It’s the best opportunity to engage with the issuer.”
Many companies and sovereigns have sought feedback on their frameworks from Neuberger Berman, she reported.
However, post-issuance cannot be ignored, according to Peasey, as even companies with the best intentions, ambitious frameworks and targets may have slippage for different reasons.
“We’ve seen some good companies publicly announcing that they missed their targets,” she said, pointing to Enel’s slippage in 10 of its SLBs in 2023. “The onus is on the investor to continue the hard work post-issuance. Just because there’s a label attached to the bond doesn’t mean that we can neglect it and hope it goes in the right direction.”
Tapping the whole market
Engaging with unlabelled debt issuers is also an important way to mobilise the funding needed for the transition to net zero. IIGCC released a discussion paper in September on the importance of a holistic and multi-pronged approach to net zero debt financing across all bond formats and frameworks.
The recommendations included strengthening bondholder stewardship and standardising the integration of net zero factors into unlabelled debt.
“The IIGCC wasn’t trying to reinvent the wheel of what [companies with] unlabelled debt should disclose,” said Peasey. “Already there is a patchwork of standards and adding more won’t help the situation.”
Instead, the organisation leveraged the required disclosures around the Corporate Sustainability Reporting Directive, Task Force on Climate-Related Financial Disclosures and EU Taxonomy – which is now mandatory for select companies.
“We want the regulators to acknowledge consolidation and interpretability of existing disclosures, and connect that to issuance in a more efficient way,” she said.
The IIGCC is also pushing for company transition plans, as it believes those are key to unlocking greater insights and enabling more efficient capital allocation.
“We want to join the dots in a more efficient way,” said Peasey. “As investors, we want companies that are making net zero commitments and then issuing debt to connect the two.”
Those who make the connection will likely become more attractive to investors and reap financial benefits, she argued.
“There is so much pressure on asset owners and managers to illustrate how their capital is contributing to net zero objectives,” she explained. “Therefore, if companies are more open and willing to demonstrate that they are heading in the right direction, naturally they are a better fit for a portfolio aligned to these targets. It also means capital will be allocated more efficiently.”
The IIGCC received significant industry feedback on its unlabelled debt report, and has been meeting bank debt capital markets teams and third-party service providers (SPOs) that validate the bonds.
“The banks, in particular, have indicated that they were already having similar conversations on this topic,” said Peasey. “We want to connect the vast ecosystem surrounding labelled and unlabelled debt issuance – investors, companies, banks, SPOs, rating agencies and regulators – and get them around a table more frequently to discuss how to get the most out of this part of the market.”
Credible transition plans
The labelled debt part of the debt issuance market is very small – just 4.2%. But the carbon-intensive or hard-to-abate sectors represent an even smaller part – only about 7% of labelled debt.
“This presents an opportunity because we’re not going to reach net zero unless these sectors are able to transition and benefit from private market capital to accelerate the transition,” said Peasey.
However, those opportunity require greater transparency in company transition plans and the way those are tied back to finance across the debt capital stack.
Peasey pointed to Transition Pathway Initiative’s recent State of Transition Report 2024, which found that 30% of the world’s highest-emitting public companies have already aligned with 1.5°C by 2050 – four times more than in 2021.
“But the intermediate and long-term targets, and how they’re going to reach them, are vague and unclear,” said Peasey. “There’s no quantification in their decarbonisation strategies – that’s the piece we need to tackle.”
She also highlighted a recent European Central Bank working paper, which provided evidence that banks – especially those committed to decarbonisation – have tightened credit standards and terms more for high-emission firms, compared to low-emission firms.
“Unsurprisingly, the interest companies are being charged on capital is becoming more expensive for higher-emitting companies,” said Peasey.
The paper also found that tightening monetary policy conditions would have a disproportionate impact on high-emitters, potentially slowing the pace of decarbonisation. “If we do get a prolonged period of tighter monetary policy, companies will potentially need to lean on private markets to help them fund the transition,” she explained.
A nascent development is the use of climate covenants in bond documentation, which is different to a labelled bond and its KPIs. “While we haven’t seen this accelerating to any great extent, it’s something that we could potentially see more of if there’s direct investor appetite,” Peasey said.
However, this would also inject more credit risk for the issuer, with broader implications for its entire debt capital stack that would need to be considered.
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