Sustainability-linked bonds provide opportunity but robust analysis is needed

Jaime Diaz-Rio Varez

Climate action requires huge capital inflows. To meet global climate objectives, investments are short by roughly $100bn (£82bn) each year.

The financial markets have a crucial role to play in innovating new financial instruments to match capital flows with investor demand and sustainable needs. 

The market for green, social and sustainable (GSS) bonds has grown rapidly, reaching $2.9tn in mid-2022. Within GSS fixed income, a notable growth area is in sustainability-linked bonds (SLBs), which experienced a 900 per cent increase in issuance between 2020 and 2021, and accounted for 10 per cent of new GSS bonds issued year to date.

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While GSS bonds must be specifically used to invest in green and/or social projects, SLBs have less stringent remits. SLBs can be used for general corporate financing but with a potential ‘step up/down’ – increase/decrease in coupon payment – or increased redemption prices, which are linked to broader sustainability key performance indicators. 

So, SLBs do have the potential to be an effective tool in enabling a sustainable transition from a broader range of issuers to raise necessary capital to finance their climate efforts.


However, it was found that corporates issuing SLBs benefit on average a sustainability premium of 29 basis points at issuance, a pricing advantage of issuing SLBs versus ‘vanilla’ corporate bonds.

This means the nascent SLB market is also vulnerable to being co-opted for greenwashing.

To avoid this, SLB issuers should select KPIs that are material and relevant to their sustainability strategy. Targets should not simply be material, but also ambitious, with materiality of the areas targeted also comes the strength of the KPIs themselves. 

Corporate issuers of SLBs may not be targeting the most material challenges to their industry in their SLB-linked KPIs.

Reducing greenhouse gas emissions are undeniably an important part of achieving the climate goals set at the Paris Agreement. However, emissions are more of a pressing issue depending on the sector, for example in the construction sector more than in telecommunications.

Our analysis involves an industry materiality matrix to determine if the given KPI is dealing with the most pressing issues facing the sector the issuer is situated in.

We would regard a KPI linked to greenhouse gas emissions focused purely on scope 1 (emissions directly created by business operations) as being weaker than a KPI targeting scopes 1, 2, and 3, which incorporate direct and indirect emissions, including those created along the supply chain. 

Main Street Partners’ research shows that in the first half of 2022, 58 per cent of SLB issuances were tied to greenhouse gas emission KPIs, but only 28 per cent of these covered all three emissions scopes.

Step-up bonds

A ‘step-up’ bond typically pays a lower initial interest rate but allows for rate increases at periodic intervals. The number and extent of the rate increase, as well as the timing, depends on the terms of the bond.