How flexible is your SLB?

Post-issuance flexibility has been less of a concern in the green bond market due to the lack of specific ESG pricing mechanisms. Green bond prospectuses generally do not stipulate mechanisms or protections around changes to the ‘use of proceeds’. There have therefore been some cases where a green investment commitment was not met, or the issuer made major changes in its framework post-issuance (largely, it should be said, as a result of external factors).

The coupon step-up (or other incentive) in SLBs changes this picture. Any post-issuance change in the ESG parameters has an impact on an investor’s return profile. Hence there is an obvious case to allow a degree of flexibility. Corporate strategies change, as do their operating environments and standards for sustainability reporting and measurements. A 2030 target may therefore risk not being fit-for-purpose in a couple of years.

This does not necessarily need to lead to “loosening” of targets. Some companies (e.g. NRG Energy) have committed to what we consider a “most-favoured green nation” statement — which means if they set more ambitious sustainability targets as a firm, they will update outstanding SLBs accordingly. Hence every SLB remains “pari passu” on an ESG basis.

Yet some ESG investors will be wary. They are increasingly developing internal methodologies to assess the credibility of new SLBs – in a recent survey we found that 78% already have such a scoring method or are in the process of setting one up. ESG investors are, of course, also under greater regulatory and societal scrutiny. Being seen to be holding a sustainability-linked bond whose terms have been “heavily diluted” is hence unhelpful – particularly if as an “arm’s length” investor there can be scepticism about the degree of ambitiousness of the target anyway. 

Looking ahead, it is likely that issuers will be expected to provide greater clarity on the flexibility they desire and give answers to questions such as: Under what scenarios would a target be re-stated? How will this be externally verified? And how will the market be informed? 

While this may seem onerous, it will likely enhance the robustness of the SLB market. Rather like a rubber band: if you stretch it too much, it risks snapping.

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