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Sustainability-linked bonds: I should Coco

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By Toby Fildes
22 Sep 2020

The recent high profile spurt of sustainability-linked bonds, including deals from Brazil’s Suzano, Switzerland’s Novartis and, coming this week, France’s Chanel, is a sharp change, after this structure — where the coupons are linked to sustainability performance targets — has made a surprisingly quiet and disappointing start to life.

Born amid much fanfare when Enel, the Italian power and gas company, brought the first two deals in autumn 2019, the product has taken a year to find any other issuers.

The drag does not seem to have been a lack of interest from investors. The Enel deals attracted big books, and investors appeared to have little problem swallowing the coupon step-up structure. 

SLBs were widely hailed as an easier, simpler alternative to green bonds. However, for issuers, they were not quite as simple as they seemed. 

Some observers have highlighted the large amount of preparatory work and market sounding an issuer has to do before issuing such a bond, compared with a use of proceeds green bond. Others have said issuers, when contemplating launching an SLB, might find it easier to issue a use of proceeds bond first, as it is a more established product with more precedents and greater investor understanding.

Unlike SLBs, it was six years after the EIB’s Climate Awareness Bond came in 2007 that the green bond market finally got a voluntary code of principles in 2013.

With SLBs, that has happened much more quickly. Market participants began working on them almost straight away after the Enel bond, and brought them out in June.

But that has been double-edged. Deals were probably delayed until the principles were ready, and the document has set high standards for the market.

Some call for patience — the green bond market, brought into the world by the EIB and World Bank in 2007 and 2008, did not really begin to take off until 2013.

That particular point weakens, though, when looking at the loan market, where facilities linked to sustainability key performance indicators (KPIs) have quickly blossomed all over the world, since Unibail-Rodamco and Koninklijke Philips brought the first ones in 2017.  

A final criticism is that despite Enel’s blowout deals, issuers and investors have in fact found SLBs complicated. Some still complain at the lack of linkage with a green use of proceeds and believe the instrument opens the way to greenwashing. Others continue to struggle working out how to price the step-up coupon. 


Eau de Frankfurt

But things could be about to change — and quickly. For there was one other, more basic, obstacle to the market. Up to now, SLBs had been excluded from the European Central Bank’s Asset Purchase Programme, making them automatically less attractive to investors.

That was irrelevant when Enel brought its inaugural deal, but very soon afterwards, the ECB restarted quantitative easing, making this a must-have look once again. 

The exclusion was not a deliberate slight on the product, but came about because all the examples issued so far have had step-up coupons. The ECB’s purchasing rules exclude all structured notes, including those with step-ups.

Now, the European Central Bank has said it will accept sustainability-linked bonds as collateral and for its asset purchase programmes, effective January 1, 2021. 

By specifically recognising the SLB structure and agreeing to buy such deals for its Asset Purchase Programme and Pandemic Emergency Purchase Programme, the ECB has bestowed on SLBs the capital markets equivalent of a papal blessing. 

Issuers, bankers and investors are likely to conclude that the ECB has decided SLBs could play an important role in creating a more sustainable European economy. After all, many believe SLBs can help companies that would not be able to issue green bonds, because of their sector or lack of appropriate assets.

The official approval is of particular interest because the European Union is about to bring in its Green Bond Standard – the first official recognition and codification of green bonds in Europe. This, however, is based entirely on use of proceeds bonds and has no place for SLBs.

With the ECB now signalling that it at least tacitly approves of SLBs, the new product may receive a leg-up.

But ECB or no ECB, issuers when considering entering the revitalised SLB market with new, funky structures might do well to heed the advice of Coco Chanel: “Simplicity is the keynote of all true elegance.” 

By Toby Fildes
22 Sep 2020