Ethical Debt Glossary: ESG, SLB, SLL, KPIs and More
(Bloomberg) -- There’s seemingly no end of names for a field that’s drawn no end of interest over the past year, whether you call it ethical debt, green finance or environmental, social and governance (ESG) financing. A key concept to understand is that some debt instruments are tied to a specific purpose, while others are linked to borrowers’ particular promises. The rise of new forms of borrowing, as well as the concerns raised by the coronavirus pandemic, helped fuel a 31% jump in sales of ESG bonds and loans to $744 billion in 2020, according to BloombergNEF data.
Borrowers that pollute too much to be plausible candidates for green bonds, at least ever since investors became uncomfortable about deals that involved sectors such as mining or transportation.
Debt that will be spent exclusively on a specific project with an environmental purpose. Green remains king in the ESG bond market, with issuers selling more than $306 billion of notes in 2020, or more than all other types of ESG-labeled bonds combined, according to BNEF data.
Funds from green loans can only be used on environmental or social-impact projects. The spending restrictions has 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 UN Sustainable Development Goals. 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 UN 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. The European Union is leading the charge, with a 100 billion-euro issuance plan in 2021 to fund its Sure employment program. Global issuance of social bonds surged eight-fold from 2019 to $148 billion in 2020, according to BNEF data.
Sustainable Development Goals (UN SDGs)
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 almost doubled in 2020 to $70 billion, the BNEF data show. Chile became the largest Latin American issuer of sustainability bonds after raising about $4.25 billion in January, with proceeds going to green and social projects.
Sustainability-Linked Bonds (SLBs)
Sustainability-linked or ESG-linked bonds are starting to take off after becoming a fixture in loans over the past few years. The central point is that borrowers set targets -- or KPIs -- and then pledge to pay a penalty to lenders if they fall short. Cement maker LafargeHolcim Ltd., for instance, will give bondholders an extra 75 basis points if it fails to meet a 10-year emissions goals.
Sustainability-Linked Loans (SLLs)
Having debt interest rates tied 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.
These notes were introduced as a way to help so-called brown industries access the ESG debt market. The idea is that companies in polluting sectors, such as oil & gas, mining or transportation, can 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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