Sustainability-linked bonds (SLBs) may have been the best invention since sliced bread, or at least since the pivot to forward-looking climate disclosures. There, I said it!
Here is an instrument that compels the entity to achieve certain sustainability outcomes. What happens when it misses that outcome? A little bit of bad press, a grumpy Bluesky skeet from a NGO perchance? You know, just the typical penalty for missing sustainability targets.
Or, wait for this, AN INCREASE IN THE COST OF CAPITAL (or decrease in the cost of capital when you actually end up achieving the target you set yourself)?
SLBs are what would happen if climate NGOs had a lovechild with Scrooge McDuck (and I mean that in the best possible way!). Public sustainability targets. Financial penalties / rewards in case of non-compliance / compliance. What is not to love?
A lot, it seems. Listening to peers across the non-profit industry, it seems like SLBs are the Devil incarnate. The SLB animosity has reached such levels that in a recent debate about green bonds, somebody asked whether I couldn’t possibly imply that I was suggesting “outcome-covenanted bonds like SLBs” as alternatives? Oh, the horror!
Can you guess what share SLBs have in the green, sustainability, social and sustainability-linked (GSSS+) market? Less than 1 percent. Even when excluding the 100-pound gorilla green bond market, “sustainable” bond issuance is 20x SLB issuance and social bond issuance 10x.
Free riders
So what went wrong? The most obvious and primary critique appears to be the lack of ambition around the sustainability targets underpinning the instrument. Climate Bonds Initiative in its 2023 Market Report identified 85 percent of SLBs as “not aligned” with the well below 2C target of the Paris Agreement.
Here is the counter: if SLBs are really such a “free ride”, surely more people would be doing it. Counter #2: we actually had three SLB with missed targets already (and probably should have had a fourth).
I don’t know about you, but companies and sustainability free-riding are moths to a flame in my experience. (If humanity had a tombstone, it would read “Here lies humanity. They loved to free ride.”)
If this was really so easy, more people would do it. And fewer people would fail.
Even when looking at the “not aligned” categorisation of the Climate Bonds Initiative, there is more than meets the eye. Not aligned includes SLBs with “economic intensity targets”, which have their challenges but also a ton of methodological benefits.
More than 90 percent of “not aligned” bonds relate to methodological quibbles, questions of scope and verification issues. In a world moving from “aligned” to “transition” concepts, the story may be greener than at first glance.
What’s more, ambition issues are a challenge, wherever you look. Theoretically, a green bond issuer can build a new thermal coal plant right next to the green project all within bounds of the bond framework – ask Australia! That hasn’t stopped the market record growth over the past decade.
Targets and trickery
I don’t mean to suggest that all is well. The SLB market may shrink this year. The concerns about the ambition level of the targets are justified. And the plethora of targets and their formulation leaves room for (potential) trickery.
The Anthropocene Fixed Income Institute accused one issuer of “creative accounting” to avoid a step-up in the coupon following an alleged “sustainability breach”.
There is one other major issue: the critique that these step-ups and step-downs are performative, rounding errors, a creative application of marketing budgets.
On the flipside, it seems SLBs suffer from an unfortunate sustainable finance ailment I would describe as “loving to hate”. Consider the critique about the instrument being performative. It seems our love of “big announcements” clouds the mind for “small actions”.
Here is what I don’t understand: since Day One, GFANZ and related target-setting initiatives have caught flak for not focusing enough on short-term targets.
Dom Torreto in The Fast and The Furious lives his life a quarter mile at a time. So do SLBs.
And just like in the Fast and Furious franchise, the road of corporate climate targets over the past two decades is littered with broken dreams. Here finally there is a chance at accountability.
And while ambition is a challenge, this seems eminently fixable. SLBs even have their own handbook out now. If that isn’t a sign, I don’t know what is!
What is more, given the size of the market, I don’t think “ambition” is the problem. In what is becoming a recurring theme of my opeds, we should be more open to failure, to trial and error.
“Learning by doin’ – the first drifters invented drifting out here in the mountains by feeling it,” is the lesson Han teaches us in The Fast and The Furious: Tokyo Drift. We should give the SLB market more space to grow and “feel it”.
Business case
For all the vitriol, the fact that SLBs seem to already have more missed targets than green bond “breaches” suggests something is working. And while those defaults may in part be linked to “freak events” like the Ukraine War, that is the point.
At the moment, companies have the choice between issuing a “sustainability instrument” with or without pricing risk. *Points awkwardly to humanity’s tombstone* ahem… I know which one I would be picking.
Investors and banks, but also NGOs and regulators, can and should make SLB issuance a cornerstone of assessing the credibility of targets and support the growth of the market. If you have a science-based target or are a signatory of a net-zero initiative, why not issue a SLB? If you are serious with your target, this should be an easy win.
Tying targets to bond issuance tells the world that you – literally – mean business. As do investors pushing issuers for that kind of accountability. Like Han, investors “have money and are in need of trust and character”. SLBs are the way to get there.
Jakob Thomä is co-founder of Theia Finance Labs (formerly Two Degrees Investing Initiative), research director at Inevitable Policy Response and professor in practice at University of London SOAS.
