Ethical Debt Glossary: ESG, SLB, SLL, KPIs and More
(Bloomberg) -- It’s a field that goes by a variety of names — ethical debt, green finance or ESG (environmental, social and governance) financing. Whatever you call it, it’s become increasingly mainstream: The amount of money raised through the sale of such bonds and loans in the first half of 2021 already matched the $700 billion for the whole of last year, according to Bloomberg data. That’s a sliver of the $100 trillion bond market, but ambitions are high. The European Union sees reshaping credit markets as crucial to blunting climate change. Innovation in the form of more flexible asset types is lowering barriers to investment, by linking borrowing costs to broad goals instead of specific purposes. The shift is also adding new terms to an already jargon-heavy field. Here’s a guide.
Money raised from this kind of “use of proceeds” debt is to be spent exclusively on a project with an environmental purpose. France, the biggest sovereign issuer of green bonds, sold 7 billion euros ($8.3 billion) in notes in early 2021 to fight climate change and pollution and to protect biodiversity. Green remains king in the ESG bond market, with more than $220 billion of such notes sold in the first half of 2021, roughly one-third of all ESG debt, according to data compiled by Bloomberg. Some in the field have begun referring to green bonds for marine and ocean-based projects as blue bonds.
Funds from green loans can only be used on environmental or social-impact projects. The spending restrictions have limited market growth, with sales already surpassed by more flexible sustainability-linked loans.
A company such as EcoVadis or Sustainalytics that provides ratings or scores on borrowers’ ESG performance, which can be used to benchmark a loan or bond’s goals. They assess companies across a range of areas often reflecting priorities laid out in the United Nations’ sustainable development goals (SDGs). Industry trade groups for both loans and bonds have also published guidelines for the main types of ESG deals.
They help companies, investors and other finance professionals factor environmental, social and governance criteria into their decisions. They can help gauge whether a company is a global citizen, or how well it’s handling risks with potentially costly consequences. A rating can cover a long list of diverse factors including carbon emissions, water usage, gender equality, fair labor practices, human rights, crime-prevention controls, board composition and shareholder rights. There’s no single method for scoring or ranking companies. Some ratings companies rely on analysts, while others focus on quantitative information or company-provided data. They can analyze a company or fund for how transparently it reports such issues, or how well it stacks up against competitors or its own performance over time.
Key Performance Indicators
In bonds or loans linked to ESG criteria, borrowers set targets known as KPIs, or key performance indicators, and then pledge to pay a penalty to lenders if they fall short. The list of KPIs are usually aligned with SDGs.
Social bonds carry the same use-of-proceed restrictions as green bonds, except the money is reserved for non-environmental projects that benefit society. In the face of the pandemic and widespread protests over racial justice, global sales of social bonds tripled to $130 billion in the first half of 2021. The EU has begun selling 100 billion euros in social bonds that will be used to fund a massive jobs program.
Social loans mirror the principles of social bonds. If the seller of a social bond lends the money raised to a social project, that’s considered a social loan.
Sustainable Development Goals
There are 17 core goals that encourage action to improve global issues such as social wellbeing, inequality and climate impact. The 2030 Agenda for Sustainable Development was adopted by all the UN member states in 2015.
Sustainability bonds are another type of use-of-proceeds debt where funds can be used for both environmental and social projects. Issuance of $84 billion in the first five months of 2021 was 18% more than all of 2020’s sales, Bloomberg data show. Chile became the largest Latin American country to sell sustainability bonds when it raised about $4.25 billion in January, with proceeds going to green initiatives along with social goals to support the elderly, people with special needs, low-income families and the unemployed.
Sustainability-Linked Bonds (SLBs)
Sustainability-linked or ESG-linked bonds are starting to take off after the concept became a fixture in loans over the past few years. The central point in sustainability-linked bonds is that rather than designate a specific ESG-worthy project, borrowers set ESG-related targets and then pledge to pay a penalty if they fall short. That means a wider range of improvements can qualify. Swiss-based cement maker LafargeHolcim Ltd., for instance, opted for the structure instead of a green issue: It will pay bondholders an extra 0.75% in interest if it fails to meet emissions goals over the 10-year life of the bonds. The targets are often based on SDGs on issues such as social wellbeing, inequality and climate impact.
Sustainability-Linked Loans (SLLs)
Connecting the interest rate on a debt to a borrowers’ ESG performance was first introduced in the loan market in 2017 and spread to bonds and the German Schuldschein debt markets in 2019. Borrowers pay higher loan margins if ESG goals aren’t met, and lower if they excel in their sustainability achievements. Sustainability-linked loans, or SLLs, have grown within four years to account for more than a third of corporate loans in Europe, and the phenomenon is spreading to the leveraged finance market as well. In the first five months of 2021, $160.5 billion were issued, more than in all of 2020. Italian utility Enel SpA signed a record 10 billion euro revolving credit facility this year with pricing tied to reducing gas emissions, and French firm Bureau Veritas SA linked its loan costs to its workplace accident rate, carbon dioxide emissions and promotion of women into leadership.
These notes were introduced as a way to help companies in polluting sectors, such as oil & gas, mining and transportation, raise funds for projects that will help curb their environmental impact. The market is distinct from green bonds as it recognizes that potential issuers will never become completely green and that some ESG investors will never want to put their money into these industries. Still, the market has yet to really take off. The few issuers to do deals include Italian utility Snam SpA, U.K.-based Cadent Gas Ltd. and Brazilian beef producer Marfrig Global Foods SA.
The Reference Shelf
- Global loan associations’ Sustainability Linked Loan Principles and Green Loan Principles.
- International Capital Market Association’s guide on Sustainability-Linked Bond Principles and Green Bond Principles.
- Bloomberg QuickTakes on green bonds, sustainability-linked bonds, sustainability-linked loans, transition bonds and ESG ratings.
- A Bloomberg News article on the varieties of sustainable debt.
- Bloomberg’s monthly update on sustainable debt volumes.
- Functions for the Market guide to search for sustainable debt on the Bloomberg terminal.
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