Sustainability-linked hybrid bonds – a matter of time

We are pleased to share this first article of a series in which we take a closer look at the potential interaction of two growing asset classes: sustainability-linked bonds (“SLB”) and corporate hybrids.

SLBs have become increasingly common in senior bond markets

In 2021, over €85 billion of SLBs have been issued globally[1], 10 times more than in 2020. Despite this increased popularity in senior format, there have been no SLB hybrid transactions by rated issuers to date[2]. The reason for this is that in order to achieve rating agency equity credit, the hybrid criteria of the rating agencies have to be met, and the typical coupon step-up seen in senior bonds would not necessarily align with that[3]. Rated hybrids represent >95% (>€200 billion) of total hybrid instruments outstanding[4], thereby reducing the pool of potential SLB hybrid issuers considerably (for the coupon step-up alternative).

While a coupon step-up SLB hybrid may currently be difficult, a potential solution could be a SLB hybrid with a coupon step-down structure. In such a structure, the coupon of the hybrid would decrease if the issuer meets pre-specified sustainability KPIs (i.e. the reverse of the coupon step-up). The step-down is advantageous to the issuer, as it would not impact the hybrid’s equity-like features and should therefore be acceptable from a rating agency’s standpoint. The task here would be securing investor demand for an instrument in which the coupon may decrease. The good news is that there have already been step-down precedents in the senior format (e.g. by seafood company Thai Union and energy company Albioma). Also, some investors have indicated they would be willing to support a coupon step-down hybrid, provided that the KPI is meaningful and challenging for the issuer to meet.

Lastly, we believe that the emergence of an SLB hybrid format would help diversify the market for sustainable debt by offering more alternatives for investors and potentially attracting new issuers (e.g. similar to how consumer / retail / energy firms issued SLB senior). Therefore, we believe that it is only a matter of time until we see the first SLB hybrid transaction with a coupon step-down in the market.

In the next article of this series, we will explore alternatives around the question at which point the underlying sustainability KPIs should be checked versus a hybrid’s first call date.


[1] Dealogic, December 2021

[2] There have been two hybrid SLB transactions by unrated issuers (Vossloh and UBM Development), in which the redemption amount increases if the issuer’s ESG ratings are below a certain threshold.

[3] See also S&P publication “Sustainable Finance: Equity Content And Sustainability-Linked Hybrids“ (10 February 2020).

[4] NatWest data, December 2021

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