The momentum behind these will continue to grow in 2021, as we set out in our macro market outlook. What are the key changes for companies we expect next year?

It’s well known that for many years, companies and investors have had to navigate a range of different sustainability reporting frameworks, standards and surveys – commonly referred to as the ESG “alphabet soup” because of all the acronyms involved.

To combat this, standard-setters have been working together to harmonise ESG disclosure requirements. In 2019, for example, the Corporate Reporting Dialogue launched the Better Alignment Project, a collaboration between the Carbon Disclosure Project (CDP), a charity that runs a global disclosure system for environmental impacts, the Climate Disclosure Standards Board (CDSB), the Global Reporting Initiative (GRI), the International Integrated Reporting Council (IIRC), and the Sustainability Accounting Standards Board (SASB) to drive better alignment of sustainability reporting frameworks.

In 2020, the SASB and the GRI announced a new collaboration to “help stakeholders better understand how the standards may be used concurrently”. During the year we also saw the World Economic Forum release a consultation paper entitled Toward Common Metrics and Consistent Reporting of Sustainable Value Creation. The paper, developed in collaboration with the ‘Big 4’ accounting firms and drawing on some of the standards we referred to above, proposes two related sets of ESG metrics, and is likely to help standardise ESG reporting across sectors.

We’ve also seen increasing efforts by regulators to encourage companies to report on their climate risk exposures. Most notably, the UK has announced its ambition to make disclosures aligned with the Task Force on Climate-related Financial Disclosures (TCFD) mandatory across the economy by 2025, with most of the requirements in place by 2023.

As pressure grows on companies to report on their material sustainability and climate-related financial risks, there’s also a clear need to ensure that their reporting is consistent. We believe standards will continue to converge, and that we’ll also see greater demand from stakeholders for better and more transparent sustainability disclosures.

A new product on the “sustainable debt” market, a sustainability-linked bond is a non-earmarked standard bond issue whose financing cost may be increased in the event of failure to achieve a sustainable performance objective. This target approach (as opposed to a project-based approach) aims at transitioning the entire capital structure of the issuer and can provide an attractive alternative to traditional use-of-proceeds instruments.

While sustainability-linked debt issuance has already moved into the mainstream in the loan markets (since the Loan Market Association released its Green Loan Principles in 2019), the bond markets have treated the concept of sustainability with a degree of caution. However, two developments in 2020 have opened the door to increased issuance of sustainable bonds:

• The publication of the International Capital Market Association’s (ICMA) Sustainability-Linked Bond Principles in June
• The announcement by the European Central Bank in September that as of 1 January 2021, sustainable bonds will be eligible instruments for its repo, monetary easing and other operations.

We expect the corporate sustainability-linked bond market to grow in the same “S-shaped” form as the corporate green bond market did in its formative years (2014–18). While there will be issuance from all major economic sectors, we’re likely to see overrepresentation from:

• More carbon-intensive sectors (such as oil & gas, steel, mining) that want to avoid being accused of “greenwashing” with a use-of-proceeds instrument
• Opex-driven industries (such as consumer and retail) that believe issuing sustainability-linked bonds represents a more credible way of demonstrating their commitment to sustainability than, say, a traditional use-of-proceeds bond or a sustainable-sourcing use-of-proceeds bond
• Small companies that lack sufficiently large projects/assets for a use-of-proceeds structure

While it would be premature to view sustainability-linked bonds as a fully-fledged asset class, 2021 will see a continuation of the debate about some of their important characteristics – including the number of KPIs, coupon step-up margin, and the use of coupon step-up proceeds.

When it comes to ESG, with climate at the top of many agendas, the “E” tends to take centre stage. This has resulted in certain sectors, particularly those closely linked with environmental sustainability, being able to take advantage of investor appetite for ESG-aligned investments. A good example is power generation, as investing in renewable energy has a significant, tangible impact on reducing carbon emissions, and neatly aligns with ICMA’s guidelines for green-labelled issuance.

Recently, however, we’ve seen a broadening of investors’ interest in ESG, with increased emphasis on the social benefits that companies provide. This has enabled more sectors to tap into ESG financing and showcase their sustainability credentials. In August, for example, Burberry became the first luxury fashion firm to issue a sustainability bond. Part of the use of proceeds will be ensuring it procures cotton more sustainably.

As a result of the growing discussion about a “green” recovery from the coronavirus pandemic, we expect an increasing focus on the broader environmental and social risks and opportunities that companies are faced with, enabling new sectors to move to the forefront of ESG.

What’s more, the growth of sustainability-linked borrowing will enable capex and opex-driven sectors to tap into “sustainability-labelled” debt within the capital markets. All companies inherently manage ESG risk in one way or another, but some may be unable to assign their expenditures to specific green projects. Sustainability-linked debt helps bridge that gap, enabling many more companies and sectors to align their overall sustainability strategy with their treasury policy.

Sustainable finance began as a largely investment-grade concern. High-yield firms, it was felt, lacked the scale or inclination to focus on ESG-related issues. But we’ve seen some encouraging signals in 2020, from high-yield companies and investors alike, including:

• Issuance of high-yield sustainability debt instruments by Suzano (sustainability-linked), Getlink (green), Volvo Car (green) and Nordex (green)
• Launches of new high-yield ESG funds by Principal Global Investors Funds (Global High Yield Fund), M&G (Global High Yield ESG Bond Fund) and Lyxor (Euro High Yield Sustainable Exposure Fund)
• Embedding of ESG ratings into high-yield transactions by Drax.

Some financial market industry groups have looked to go further, fundamentally reshaping the structure of the high-yield debt market. For example, in July, the Association for Financial Markets in Europe (AFME) launched a set of ESG guidelines for the European high-yield market. Meanwhile, the European Leveraged Finance Association (ELFA) is looking to build buy and sell-side consensus around detailed ESG best practices, including sector-level ESG KPIs that should be incorporated in any high-yield bond offering.

In short, we expect ESG high yield to come of age in 2021, with ESG-specific questions likely to feature in the disclosure and diligence of most European sub-investment grade transactions by the end of the year. The breadth and depth of sustainability data for this asset class will also grow, with ESG data agencies catering to growing investor and regulatory demands in this respect. Finally, sustainable debt structures will start to emerge in all the major high-yield sectors including energy, debt repurchasers (buyers of distressed or underperforming debt) and telecoms.