Recently, Nasdaq hosted an event on the young but growing market for Sustainability-linked Bonds (SLBs) on the Stockholm Exchange. The event featured speakers from Atrium Ljungberg, Cicero, Shades of Green, Danske Bank, SEB, Spiltan Fonder, Swedbank Robur and White & Case.
With an SLB, an issuer can emphasize its commitment to reach its sustainability targets, communicating their journey to become a more sustainable company and valuable credit in the eyes of investors.
Although the market is still working to find consensus over numerous topics, several benefits are evident from the introduction of SLBs as a complement to the wider sustainable bond market. Below are key takeaways from the seminar:
Clarity and preparation are key
A common denominator in all of the discussions was the importance of clear and carefully defined key performance indicators (KPIs) and sustainability performance targets (SPTs). Uncertainty about these definitions will not only lead to difficulties in valuing the bonds post-issuance for investors but could also result in unwanted discussions about their interpretation in connection to observation dates and trigger events.
One panelist noted that it is usually not as straight forward as plugging pre-existing sustainability goals into an SLB framework, you also need to consider things like timing of the goal-achievement in relation to the tenor of your forthcoming bonds. In fact, SLB issuance could be more demanding for an issuer than for other sustainable bonds, especially if the issuer’s frameworks need to be frequently updated to accommodate changes and new observation dates, among other accommodations.
Clear definitions and calculation methodologies are crucial for investors to understand and follow up on their investments. This further implies that the construction of SLBs requires the inclusion of more speaking partners, both internally and externally, at an early stage to ensure that the definitions and targets defined in the frameworks can be converted into enforceable legal language in an adequate way by the time of issuance.
Sustainability-Linked Bonds are engaging instruments that furthers the dialogue between issuers and investors about long-term sustainability strategies.
Notably, the event showcased how the very nature of sustainability-linked bonds and their large variety of options, structures and themes bring one clear added value as a centerpiece of discussion about issuers’ overarching sustainability strategies. It was also noted that SLBs put the sustainability department in the driver’s seat when it comes to investor dialogue in a more prominent way than we usually see before issuance of conventional green bonds.
SLBs have the potential to revamp the Swedish sustainable bond market and allow more types of issuers to issue bonds covering a broader set of sustainability themes.
Sustainability linked bonds have the potential to broaden the sustainable bond market, both in terms of issuer types and in terms of the sustainability themes covered. We have already seen evidence of this as new sectors have joined the sustainable bond market through SLBs but also from the broad integration of social/governance KPIs in the bonds issued so far.
SLBs put a large emphasis on issuers’ disclosure practices, which could lead to more frequent sustainability reporting in general.
One panelist noted early indications that SLB issuance may lead to more frequent sustainability reporting as some of the early issuers have decided to communicate the progress of their sustainability targets on a quarterly basis.
It was also clear from the discussions that SLB reporting will be paramount for investors as they need to understand and value bonds in connection to trigger events. As reports connected to the fulfillment of SPTs may effect the price of securities admitted to trading on a regulated market, Nasdaq has incorporated a recommendation for all issuers to consider their processes and means of disclosure around SLBs and whether it should be treated as inside information.
SLBs are a powerful tool for investors looking to reach net-zero emissions in their portfolios – but only when issuers convey a credible and verifiable strategy to get there.
Just as with use-of-proceeds bonds, the label itself may catch investors’ attention. However, the investors at our event were clear that all types of sustainable bonds are assessed in the larger context of the issuers’ sustainability strategy. Therefore, it is vital that performance targets associated with the SLBs are material and ambitious, presenting a credible path to reach the issuers long-term goals.
The jury is still out when it comes to appropriate size and structure of bond variation/step-ups.
Generally, it was noted that the Swedish SLBs have so far been issued with low penalties for non-fulfillment of predefined targets according to investors. Small penalties could be perceived as the issuer having a low degree of faith in its ability to meet the targets. On the other hand, it was also raised that it may not be fair to penalize an issuer who is very close to reaching its target on the observation date either.
Therefore, one participant suggested that SPTs could be structured with a range that define goal fulfillment rather than a binary goal. That way, an issuer who reaches, for example, 49% of carbon emissions reduction would not necessarily be penalized because their goal was set at 50%.
Moreover, the panelists also discussed the benefits of integrating a discount rather than a penalty. No stakeholder wants to see issuers fail to meet their targets. A discount would match the investors’ view that a more sustainable company offers a better risk/return profile. With that in mind, the fulfillment of an issuers sustainability performance targets could very well justify a discount at redemption or a step-down.
In the end, there is a balance to strike between setting truly ambitious targets and integrating step-up mechanisms that create a large enough incentive for the issuers to reach those targets.
Is there an SLBnium?
While we see increasing evidence of a so called “greenium” in the green bond market, there is still insufficient evidence to suggest issuers should expect the same type of premium when issuing SLBs.
The lack of an evident premium for SLBs is explained by the fact that no SLB-specific mutual funds or portfolios have been launched in the Swedish market at this time, while there are mutual funds that have a clear policy to only invest in labelled green bonds.
Notwithstanding the lack of evidence for an issuer premium on SLBs, the investors sent a clear signal in saying that sustainability is integrated into their credit analysis, which means that the achievement of ambitious and material goals should result in an improved credit and thus a better valuation.
Conclusion
Sustainability-linked bonds are a welcome addition to the broader sustainable bond market in Sweden. They provide an avenue for new sectors to join the market and allow for more social-themed bonds to come to market in the coming years.