Sustainability-Linked Bonds: alternative steps

22 minute read

The Sustainability-Linked Bond (SLB) market has brought an innovation to the thematic bond market by allowing the proceeds to be used for general corporate purposes. The issuer is penalised (or rewarded) for meeting (or not meeting) its Sustainability Performance Targets (SPTs).

The most common structure involves an issuer paying an increased coupon payment to investors, a ‘step-up’, when a target is missed. One criticism of this structure is a perceived lack of alignment between investors and issuers on sustainability objectives, with the investor seemingly benefiting from an issuer missing its targets.

While we consider that the coupon pay-out should be viewed as a hedge for investors rather than a bonus payment, we note that the market is responding to this concern by developing alternative structures, where the step-up proceeds are used either as a donation to charity, or to purchase carbon credits or renewable attribution certificates.

While these may have identical financial outcomes for the issuer, the SLB will be a different product for the investor. In this note we analyse some example SLBs using these new structues, to evaluate their benefits for investors, issuers, and the broader market.