It was a landmark week for the sustainability-linked bond market, with four new deals totalling US$2.8bn, bringing the amount of debt issued in this format to US$11.75bn as the rapidly developing asset class becomes a mainstream part of sustainable finance.
Swiss cement maker LafargeHolcim and US utility NRG Energy sold new SLBs, Brazilian pulp and paper company Suzano tapped its recent deal and French energy management business Schneider Electric issued the first-ever sustainability-linked convertible bond.
Suzano’s tap showed the flexibility of SLBs to raise additional financing and Schneider Electric’s SLCB included innovative social (rather than just environmental) targets against which interest costs will be judged, as the asset class continues to evolve.
“I think investors see the structure as a mechanism for accountability and we are seeing increased investor acceptance and understanding of the SLB instrument," said Farnam Bidgoli, head of sustainable bonds for EMEA DCM at HSBC.
The uptick in SLB issuance precedes an expected surge in early 2021. The European Central Bank will start accepting SLBs as collateral from January 1 if they are linked either to environmental targets or one or more of the UN’s Sustainable Development Goals.
Pushing boundaries
LafargeHolcim’s €850m SLB issue pushed the boundaries with a challenging 10-year maturity and deviated from recent deals by not offering a multi-year step-up. Instead, a 75bp penalty applies only to the final coupon payment if it misses its KPI commitments.
The company said that the bigger step-up (although a one-off) reflected its "ambitious" and "science-based" target to cut Scope 1 CO2 emissions per tonne of "cementitious material" to equal or below 475kg by December 2030 – a 17% reduction on 2018. It added that the tenor was a reflection of the time required to meet the target.
"It was important that we had a coupon step-up that reflects the importance of our commitment," said Geraldine Picaud, group CFO at LafargeHolcim.
Investors' questions focused on the company’s sustainability strategy, innovations such as the introduction of green products and the capex required to meet the target.
"Lafarge did a pretty good job in terms of structuring, I think. The maturity and the coupon structure make sense because I would argue that to have meaningful goals they can't just be one or two years," said Rhys Petheram, a fixed-income fund manager at Jupiter Asset Management.
Some might think an average annual reduction of 1.4% is not in fact particularly ambitious, but the volume of orders suggested that investors thought otherwise or (perhaps most likely) were not especially interested in the sustainability angle. The book settled at €3.8bn and the spread was set at 77bp over mid-swaps, well inside initial price thoughts in the 110bp area.
First from the US
There was also some scepticism about the deal from NRG Energy. The company became the first US-based issuer to sell an SLB, raising US$500m while committing to cut its CO2 emissions. But not all investors were convinced that it has a clear path to wean itself off fossil fuels.
“While we are supportive of sustainability-linked notes in general, we don’t support them if they are just being used to reduce greenhouse gas emissions by fossil fuel-oriented utility companies,” said Peter Schwab, portfolio manager of the Pax High Yield Fund, which is advised by Impax Asset Management.
Suzano is another controversial company that says it is using SLBs in its transition to becoming a better corporate citizen. Its deal – a US$500m tap of its September 3.75% 2031 notes – highlighted an advantage of SLBs over green bonds: the fact that SLBs can be added to. Green bonds are hard to tap because they are “use-of-proceeds” instruments linked to specific projects and expenditure.
"Again, you can see the benefits of the SLB structure from a financing perspective as it allows more flexibility with regards to the ability to tap," HSBC’s Bidgoli said.
Meanwhile, Schneider Electric opted for three KPIs: two social targets regarding women in management positions and training underprivileged people in energy management programmes; and one relating to CO2 reduction.
Patterns emerging
Before the recent flurry, five companies had issued SLBs, totalling just under US$9bn: Italian utility Enel in US dollars, euros and sterling, followed by Suzano, luxury retailer Chanel, pharmaceutical company Novartis and Japanese real estate developer Hulic.
A sixth, Etihad Airways, issued US$600m of five-year unlisted "transition sukuk", which it said were the first of its kind and the first SLBs from the high-emitting airline industry.
The deal has an unusual framework that allows it to issue either project-specific use-of-proceeds bonds, or SLBs that tie financing costs to achieving ESG targets. It's not clear how much of each type of instrument has been or will be issued.
Most of the SLB deals had carbon-linked targets to either increase renewable energy or reduce CO2 emissions, according to a research note from NatWest Markets. Other targets included indirect emissions, patient access, and a move to 100% renewable energy.
Most of the bonds had the same 25bp coupon step-up if the company fails to meet targets – “25bp is the answer, what is the question?”, as the NatWest note joked – and most measure targets at year five, or 60% of bond maturity.
"This is a careful balancing act between setting meaningful targets while also offering a strong enough economic incentive to meet the target, for example through multiple years of residual (stepped-up) coupon payments," the NatWest note said.
The average size of SLBs is around 40% larger than the average green bond issue, due to the lack of restrictions on use of proceeds.
Further development is expected in coming months as more KPI targets are established that will allow better comparison between companies and sectors.
"For sure, I will always be tempted to add a sustainability target to a bond issuance, and I will always consider it. We will always try to enforce our commitment with the sustainability target whenever it makes sense," LafargeHolcim’s Picaud said.
Additional reporting by David Bell and Ed Clark
