Sustainability-linked bonds could crack transition nut in EM
The recent burst of sustainability-linked bonds could catch on in the emerging markets because they can solve the problem of constructing sustainable financings for companies that are not green yet, but in transition.
Green bonds have made only limited headway in emerging markets, especially among companies. The latest product — sustainability-linked bonds with variable interest rates — could have a fresh chance of success, because it addresses several needs EM issuers and investors have.
Sustainability-linked bonds (SLBs) were invented by Enel, the Italian power company, with a deal in September 2019. Unlike with a green bond, the issuer enjoys unrestricted use of proceeds. But it commits to a company-wide sustainability target, and will pay investors a coupon step-up, typically 25bp, if it fails.
The second issuer was an EM firm: Suzano, the Brazilian paper company. It raised $750m in September with a bond whose coupon will rise if it fails to cut its greenhouse gas emissions intensity 5% by 2025.
“EM issuers are interested,” said Sarmad Mirza, executive director of debt capital markets at Standard Chartered Bank in Dubai. “We are hoping to bring the first one from the Middle East very soon.”
Excluding China’s regulated market, only 13% of all green, social and sustainability bond issues have come from emerging markets.
“The reason why it hasn’t caught on,” said Mirza, “is that the first question many issuers ask is: ‘if I go down this path, is there a price advantage? Is there investor diversification? If not, I still care about ESG, but I don’t necessarily need to set up a framework for a green bond.’”
EM issuers do not yet gain a clear price or diversification advantage with green bonds, he argued, because most specific environmental, social and governance funds are in the developed world and lack mandates to invest in EM.
SLBs, however, appeal to mainstream investors as well as SRI or green investors, said Orith Azoulay, global head of green and sustainable finance at Natixis in Paris.
Her bank is finding EM issuers interested in the product. An important reason is that SLBs can solve the problem of constructing sustainable financings for companies that are not green yet, but in transition.
“When the market examines a transition instrument, everybody wants to see first and foremost where the organisation is going,” said Azoulay. An instrument based on the whole organisation’s performance can address this better than one based on a specific pool of assets.
“Across EM what would be interesting,” said Mirza, “is not just a standard SLB but to pair it with a transition bond. That’s the really exciting thing and why it will expand.”