Despite the huge popularity of green bonds, their specific environmental focus and use-of-proceeds structure mean they might not be the best option for every issuer as some issuers have insufficient environmental projects to issue a green bond. There is also a role for other types of sustainable bonds, like the more flexible sustainability-linked bonds, as a financing tool for companies that still want to take positive steps towards sustainability. Analysis¹ by NN Investment Partners (NN IP) indicates that sustainability-linked bonds do not command the equivalent of a green premium (greenium) which is the case for some green bonds. This shows that there is more scepticism in the market as to the how sustainable SLBs really are. So, how can investors ensure they select the right SLBs, avoid the risk of sustainability washing and use these versatile investment vehicles to fulfil sustainability goals in their credit portfolios
Sustainability-linked bonds (SLBs) have key performance indicators (KPIs) set by the issuers that are aligned with their sustainability strategies. These goals can be more general and overarching rather than the bond’s proceeds being tied to the financing of specific projects that create a positive environmental impact, which is the case for green bonds. The market for SLBs has grown rapidly from USD 5 bln in 2019 to over USD 19 bln in the first half of 2021².
Annemieke Coldeweijer, co-lead Portfolio Manager Sustainable Credit, NN Investment Partners: “SLBs offer companies an instrument to tackle sustainable or social issues that are not directly climate-related. Many are not large CO₂ emitters and do not have sufficient environmentally linked financing needs to enable them to issue green bonds. Issuing an SLB gives these companies the opportunity to look beyond the pure environmental theme at the bigger sustainability picture.”
Investors have some degree of scepticism about SLBs because there is less concrete information on how their proceeds will be used and the potential impact they will have. The flexible structure of the KPIs also makes “sustainability washing” easier. To combat this risk, NN IP recommends investors should consider four key factors when assessing the robustness of a bond’s sustainability key performance indicators (KPIs):
Climate-related
Any KPIs related to the climate crisis should be aligned with the company’s carbon neutral target by 2050 (1.5°C scenario). Issuers should establish this target and have it verified by an external party, such as the Science Based Target Initiative.
Focus on emission scopes
Climate-related KPIs should focus on the key emission scopes of the issuer. For example, while some companies have more emissions in Scopes 1 and 2 – directly generated by the company or related to its upstream activities, such as its power sources – others, such as automotive manufacturers, have more emissions in Scope 3, which include emissions that are a consequence of a company’s operations but are not directly owned or controlled by it, such as when consumers use its products.
Reflect true business-related sustainability issues
SLBs should have KPIs that accurately address the crucial sustainability problems that the issuers are facing. Recent examples include healthcare company Novartis, which issued a sustainability-linked bond with KPIs linked to patient access, and food retailer Ahold Delhaize, where the SLB had KPIs linked to food waste³.
Independently verified
The KPIs should be well-documented and verified by independent parties, such as Sustainalytics or ISS. Issuers should report on their progress in terms of the KPIs annually and have them audited externally.
Annemieke Coldeweijer added: “Transparency and corporate disclosure are key when it comes to assessing the impact of an SLB and a company’s ESG targets and achievements. Data and reporting on sustainability is still a challenge for both companies and investors, and although increasing regulatory requirements are improving standards, there is still some way to go. This is also why in our bond selection process we do not rely solely on data from the companies themselves or on third-party ESG data sources alone. We carry out our own thorough ESG analysis of the issuer, both qualitatively and quantitatively. This ensures we develop a proprietary view on the ESG/sustainability performance, before investing in any issuer and in any bond.”
To hear more about sustainable credit, you are invited to register for NN IP’s Headlight on: Making Credit Sustainable online event on 20 May. NN IP will be joined by a panel of experts from ING, Julius Bär and Bank für Kirche und Caritas, who will provide helpful insights for investors on building more sustainable portfolios. Registration is available here.
¹Source: NN Investment Partners. Includes analysis of bonds issued by VW, Daimler, Philips, VF Corporation, Ahold, Tesco and Novartis
²Source: Bloomberg New Energy Finance
³For illustration purposes only. Company name, explanation and arguments are given as an example and do not represent any recommendation to buy, hold or sell the stock, or in any way invest in these companies. The security may be/have been removed from portfolio at any time without any pre-notice.
