Green vs Sustainability-Linked Bonds
Europe continues to lead the world in the issuance of sustainable bonds.
The European Central Bank (ECB) made headlines when they committed to buying sustainability-linked corporate bonds as part of their quantitative-easing program and to accept them as collateral for loans to commercial banks. Around the same time, the European Commission committed to funding 30% in covid stimulus with green bonds. This will cause the green bond market, which was already exploding without much help from the U.S. government and regulators, to double in size.
Green bonds are similar to traditional bonds in structure.
With a green bond, the issuer is committing to use the bond proceeds for green projects or to refinance eligible green assets. Here are some examples:
Apple issued the 2017 Green Bond to finance its transition towards renewable energy, build green buildings and improve water efficiency in their operations. For example, some of the bond proceeds were used to install solar rooftop systems to reduce emissions from their Japanese operations.
The city and county of San Francisco issued a bond to fund a hydroelectric facility, solar and wind projects, and energy-efficient streetlights.
Pepsi issued a bond to invest in eco-friendly plastics, sustainable packaging, and cleaner transportation.
Sustainability-linked bonds have a unique structure.
With sustainability-linked bonds (SLBs), the coupon rate, or interest payment, is linked to pre-determined environmental, social, and governance (ESG) targets. The issuer can use the bond proceeds for whatever they want, unlike a green bond which must be used for a specified green project. If the issuer fails to meet their target, they have to pay a higher rate to investors. The first SLB was issued in 2019 so they are brand new, but expect to hear more about them in the future. Here are examples of SLBs:
Novartis issued $2.2B in SLBs. The target is to increase patients’ access to treatment for malaria and other illnesses in certain countries by 2025. “If an external verifier determines that Novartis failed to meet those targets by the 2025 deadline, then the coupon rate on the bonds, which is set at zero, will increase to 0.25% for the following three annual coupon payments until the bond matures in September 2028.” (Source: WSJ)
Enel issued $4.4B in SLBs. The first SLB ever issued, Enel needs to prove that it is generating 55% of its energy capacity with renewable sources by the end of 2021 or the interest due to investors will increase by 25 basis points annually. (Source: WSJ)
Chanel issued €600m in SLBs. If Chanel does not meet the targets, they agreed to pay an additional 75 basis points to investors when a 2031 bond comes due. The pre-determined targets are:
Decreasing CHANEL's own absolute emissions by 50% by 2030 (from a 2018 base year)
Decreasing CHANEL's supply chain absolute greenhouse gas emissions by 10% by 2030 (from a 2018 base year)
Shifting to 100% renewable electricity in CHANEL operations by 2025. (source: BNP Paribas)
Green Bonds versus SLBs
Both green bonds and SLBs are appealing to entities looking to raise capital for projects because they attract a wider pool of investors than traditional bonds alone.
SLBs are more results-based. For example, rather than committing that proceeds will be used to install solar panels, an SLB target of cutting emissions in half will require a review of a company’s entire operations. Bond proceeds could be used to install solar panels, but the company is not tied to that specifically if another opportunity or project arises that is more effective at reducing emissions.
SLBs tend to experience lower staffing and administrative costs than green bonds. Issuers of green bonds have to spend time and money isolating green projects in order to prove how the bond proceeds were used.
Both green bonds and SLBs need standards in place to ensure there is no “greenwashing”. Greenwashing is when issuers use the "green" label even though the bond proceeds are used for unsubstantiated or misleading environmental benefits.
For green bonds, the Green Bond Principles (GBPs) offer credibility. The GBPs require that issuers document how the bond proceeds will be used, provide annual updates, and appoint an external reviewer to ensure the entire process was completed to the GBP standard.
For SLBs, the ICMA recently issued voluntary guidelines for issuers to ensure the targets are measurable, verifiable, and relevant.
The future likely includes both green bonds and SLBs. Not every company has a singular, expensive green project that justifies the issuance of a green bond. A more general-use SLB with a target to aggressively reduce emissions may be a better fit for companies that have multiple green projects and require flexibility with the proceeds. The market for green bonds and SLBs is still new, but with the ECB supporting both in a big way, expect to hear more about these innovative products in the future.
Linda Rogers, CFP®, EA, MSBA is the owner and founder of Planning Within Reach, LLC (PWR). Originally from New Jersey, Linda services clients nationwide and is based in San Diego. She leads the design of PWR's investment portfolios which utilize broad, low-cost investments that integrate environmentally, socially, and governance (ESG) factors.
Planning Within Reach, LLC (PWR) is a virtual fee-only and fiduciary wealth management firm offering one-time comprehensive financial planning, ongoing impact-focused investment management and tax preparation services. PWR is a woman-owned firm that specializes in busy professionals and impact investors. Planning Within Reach, LLC and their advisors do not receive commissions and do not hold any insurance licenses or brokerage relationships.