Obscure Bonds to Enter Major League of ESG Corporate Debt Market

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Sales of sustainability-linked bonds are set to surge amid rising market awareness and the start of European Central Bank purchases.

The notes, known as SLBs, will swell to as much as 30% of global corporate ethical-debt sales next year, according to Cristina Lacaci, Morgan Stanley’s EMEA head of green and sustainability bonds. They accounted for less than 10% of the $86 billion market this year, based on data compiled by Bloomberg.

Issuance of SLBs, which link borrowing costs to sustainability targets, has slowly begun to pick up, aided by a new marketwide framework and the ECB’s plan to start buying notes with environmental targets in January. That has helped lure seven new issuers worldwide since August, including Chanel and LafargeHolcim Ltd., boosting outstanding global volume almost threefold to $11.3 billion, based on data compiled by Bloomberg.

All this helps to “give sustainability-linked bonds a sense of legitimacy,” Lacaci said. “They are not a niche market anymore.”

The notes let companies tap booming demand for ethical debt products, without having to ringfence proceeds for projects with direct environmental benefits -- as is the case for traditional green bonds. Borrowers instead pay a penalty if they miss companywide goals such as cutting pollution.

Obscure Bonds to Enter Major League of ESG Corporate Debt Market

In Europe, the biggest market for non-financial ethical debt, the growth of SLBs will help socially responsible bonds avoid the worst of a 2021 slowdown in overall euro corporate issuance, according to Commerzbank AG. Total sales of environmental, governance and sustainability bonds may reach at least 40 billion euros ($49 billion), with risks to the upside, the bank said.

“Thanks to the rise of sustainability-linked bonds the 50 billion-euro mark could emerge as the lower limit only a few years from now,” it said in a credit outlook. ESG sales hit that level in 2019 and have only dipped slightly this year after coronavirus disruptions, the bank said.

SLBs struggled to gain traction after Enel SpA opened the market in September 2019, partly because virus upheavals prompted companies to focus on quicker and easier forms of fundraising in the first half of this year. Investors have had to think about how to value notes with uncertain penalty payments. They also have to adapt to monitoring companywide indicators, such as emissions levels, and making sure that bond targets are as sustainable and challenging as borrowers claim.

“The devil is in the details,” said Lucy Speake, head of European credit at Insight Investment Management, which oversees 732 billion pounds ($986 billion). Still, for investors that want to demonstrate environmental principles, SLBs “provide much clearer evidence” than green bonds, she said.

Asset managers may also ease the growth of SLBs by becoming more involved in the process of drawing up notes, and setting trigger levels, said Pierre Bose, chief investment officer at Tiedemann Constantia AG, which oversees $22 billion.

“Investors can be part of that dialog, not just with issuers but with underwriters as well,” he said. “These three parties should be coming together next year to drive the market forward.”

©2020 Bloomberg L.P.

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