How Chanel Set New Fashion in Environmental Bonds: QuickTake

(Bloomberg) -- A flood of ethical investors is driving down borrowing costs for companies selling debt used for environmental or social projects. That’s great if you’re a solar-panel maker, as you can issue low-cost green bonds to help pay for your new factory. Ring-fenced green funds don’t work so well if your business only spends limited amounts on infrastructure and research, or if your sustainability plans encompass a variety of different projects. That’s why fashion house Chanel opted to sell sustainability-linked bonds -- a relatively new type of debt that offers the potential cost benefits of green bonds without the spending restrictions. Instead, the notes hinge on companies pledging to do good and agreeing to pay penalties if they fall short of expectations.

1. How do sustainability-linked bonds work?

By tying debt costs to measurable and verifiable companywide goals, known as key performance indicators, or KPIs. Issuers set targets with timetables and then make extra payments to bondholders if they fail to achieve them. The penalty could be higher coupons during the life of the bond or an additional payment on maturity. Chanel, for instance, agreed to give bondholders an extra 75 basis points when a 2031 bond comes due, if it misses an emissions goal.

2. What kind of targets?

Issuers can pick from a range of environmental, social and governance (ESG) metrics, depending on their operations and existing sustainability plans. Just before Chanel’s climate-linked sale in September, drugmaker Novartis AG did a 1.85 billion-euro ($2.2 billion) deal benchmarked against access to medicines in developing nations. Other possibilities include boosting the number of women in management positions, reducing fossil-fuel investments or hiring from disadvantaged regions. In the more mature sustainability-linked loan market, some deals are tied to ESG ratings.

3. Why not just sell green bonds?

Because the funds can only be used for projects with a direct environmental impact. Financing from sustainability-linked bonds is unrestricted -- usable for anything, including everyday operations. That flexibility can make the notes complementary to green bonds for some borrowers. Advocates also contend that ESG-linked debt is an effective way to drive companywide change because financial penalties and potential public loss of face will compel top-level managers to focus on environmental plans. Social and sustainability bonds have similar use-of-proceeds restrictions to green bonds.

4. How fast is this growing?

The market has made slow progress, with less than $10 billion of syndicated deals. After Enel SpA sold the first sustainability-linked bonds in September and October 2019, there were no more offerings worldwide for about a year. Activity has picked up, including a market-first sterling deal from Enel in October. This may be partly due to the publication of market standards in June by the International Capital Market Association, a trade group. Issuance may get another spur from sustainability-linked bonds with environmental targets becoming eligible for European Central Bank stimulus programs in January.

The Reference Shelf

• ICMA’s sustainability-linked bond principles and a Bloomberg News article about them.
• QuickTakes on green finance and the risk of greenwashing.
• A Bloomberg News article on how emerging-market banks may use sustainability-linked bonds.
• Bloomberg Opinion’s Marcus Ashworth discusses the Chanel deal.

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