Following the strong adoption by the loan market of sustainability-linked loans (SLLs), sustainability-linked bonds (SLBs) are quickly becoming important tools for corporates to align their financing needs with their sustainability objectives. As more companies commit to reaching net zero, the role of sustainability-linked finance is an important lever for treasurers to direct capital towards pressing sustainability challenges within their organisations.
SLLs are structured in a way that the interest margin on the loan is directly tied to a predefined sustainability target. The key performance indicator (KPI)-linked mechanism in SLLs was then applied to the bond market in the form of the SLB, helping embed credible, transparent and often science-based targets into bond financial characteristics. As the sustainable-linked finance market evolves, structures are being extended to other areas of corporate support, including hedging instruments.
Science-based targets provide companies with specific, measurable goals and a practical road map to help limit global warming to 1.5°C, by providing clear action plans in the companies’ strategies to reduce their greenhouse gas emissions. This includes addressing scope 1 (direct from own sources), 2 (indirect) and 3 (total value chain) emissions.
However, beyond environmental or greenhouse gas (GHG)-focused KPIs, some companies are supporting social impact, or accelerating the shift towards circular economy.
Let us look at some case studies of sustainability-linked bonds and loans in line with different companies’ sustainability strategies.
As a business committed to achieving net zero by 2035, Tesco has been at the forefront of harnessing sustainable finance in the UK. In October 2020, Tesco became one of the first UK retailers to establish an SLL through a £2.5bn revolving credit facility linked to emissions reduction, renewable energy sourcing and food waste reduction.
In January 2021, Tesco then followed on from the SLL by issuing its first SLB, raising €750m. Not only was it the first SLB issued by a UK-rated issuer, but it was also the first SLB from a retailer.
Tesco’s SLB coupon is tied to the company’s sustainability performance related to scope 1 and 2 GHG emissions reduction by 2025, and the deal received strong investor demand and was more than six times oversubscribed. Tesco demonstrated a very consistent approach to integrate sustainability throughout the loans and bonds instruments, highlighting how KPIs can help accelerate the company’s sustainability impact.
In February 2021, H&M became the first EUR issuer to complete an SLB in the Nordics. The €500m transaction contains both a circular economy KPI related to proportion of recycled materials used and targets on scope 1, 2 and 3 GHG emissions. This landmark SLB supports H&M’s sustainability strategy to be climate positive by 2040.
In April 2021, Coats, the world’s leading industrial thread company, which has a 2050 net zero target, signed an inaugural $360m ESG-linked loan. The three-year facility embeds sustainability targets tied to energy intensity, employee engagement and amount of thread made from recycled raw materials.
In November 2020, Schneider Electric issued the first ever sustainability-linked convertible bond. Schneider Electric chose three KPIs with associated 2025 objectives and methodology, which are to be tracked, reported and verified by EY & Associés, including:
The convergence of ESG risk, sustainability-transformation strategy and funding requirements is embedded into the functioning of sustainability-linked financing solutions. On the SLB side, investors look for a strong relationship between the disclosure of a companywide KPI and their own holistic analysis of issuers in their portfolio. Both SLLs and SLBs also measure the implicit ESG risk, as this is reflected in the pricing of borrower’s debt, as the coupons or other financial characteristics change based on ESG performance.
Ensuring KPIs are material, relevant and ambitious – alongside strong disclosure – is critical to the successful use of an SLB or SLL by a corporate.
Emissions reduction and environmental targets are gaining special attention due to European Central Bank (ECB) eligibility, as the ECB will only buy SLBs linked to environmental targets for now. Investors are engaging more in the decarbonisation strategy of a company, though, and they value the SLB specifically for transparency and tracking as a dashboard for how issuers are managing ESG across their business.
Investor interest in the SLB is clear from the ‘greenium’ or pricing benefits issuers have enjoyed. Tesco’s SLB, for example, priced 15bps inside its secondary curve. Some of this performance was definitely due to the stickiness of investors and the support they wanted to show for the development of the SLB market.
While some difference remains in terms of investors’ expectations on KPIs, we are witnessing a convergence in the approach of both SLL and SLB by trading bodies on loans and bonds. In May, a new version of the Sustainability-Linked Loan Principles was released by the Loan Market Association, the Asia Pacific Loan Market Association, and Loan Syndications and Trading Association. Given the established SLL market, many corporates with existing SLLs will likely explore SLBs as well, highlighting the need for greater convergence.
We expect a continued and sustained growth of the SLL and SLB market segment, with more companies deciding to embed their long-term sustainability commitments into financing cycles. The increased investor momentum will fuel this further in the SLB market as well, with the ECB providing a supporting factor.
Finally, looking ahead to COP26, we expect further corporate net zero commitment announcements to accelerate the integration of science-based targets into financing structures, and the SLL and SLB provide a useful tool in the transition road map ahead.
Agnes Gourc and Cecile Moitry are co-heads, sustainable finance markets, BNP Paribas
