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04 March 2021



Covid-19 has intensified the pressing need for transition, while exposing the myriad logistical, social and environmental risks associated with the move away from fossil fuels. But the transition has also expanded to include a much wider variety of issuers, new debt products and renewed investor expectations. On 25 February, in Events Radar’s third annual 50 Shades of Green webinar, Keith Mullin chaired a vital and timely discussion with our expert panellists Federica Calvetti, Manuel Adamini, Michelle Horsfield, Nicholas Pfaff and Faith Ward.

The future is sustainability-linked

Issuance in the small but rapidly growing area of sustainability-linked bonds (SLBs) has accelerated this year, opening up the green bond market to a wider array of issuers without access to a dedicated pool of green assets with which to peg a traditional use-of-proceeds bond.

“The pace at which this type of issuance is developing in the market is unprecedented,” said Federica Calvetti, Head of ESG Debt Capital Markets, EMEA, at Deutsche Bank.

“There are reasonable grounds to see SLBs, at least for the corporate sector, will become the reference format”

Following a slow take up after Enel’s first ever deal in sustainability-linked format back in 2019, sustainability-linked bonds last year made up around 9% of euro-denominated ESG-labelled IG corporate debt, Bond Radar data shows.

And this trend is expected to continue. “There are reasonable grounds to see that this SLB market, at least for the corporate sector, will become the reference format for the sustainable bond market,” Calvetti added. “The amount that can be issued is not limited by the amount of assets in the company’s portfolio today.”

As well as an announcement by the ECB last year that it would put SLBs under its asset purchase programme, a major catalyst for new supply was the publication in June 2020 of the Sustainability-linked Bond Principles, which provide guidelines on structuring, standards and reporting.

“We have just under four hundred members and observers in the overall market initiative supporting these principles,” said Nicholas Pfaff, Head of Sustainable Finance, International Capital Market Association (ICMA).



Nicholas Pfaff, ICMA

“SLBs open up a whole area of the economy that could not easily subscribe to the use-of-proceeds model,” he added. Both of the euro investment grade SLBs issued this year have come in the retail sector, with heavily over-subscribed deals for UK supermarket Tesco and Swedish clothing giant H&M.

Inclusive and flexible

But the market is also open to carbon-intensive sectors. Franco-Swiss cement group Lafargeholcim for example sold a sector-first SLB last year with a KPI linked to CO2 reduction. More recently, French energy giant Total said that in future all its bonds would be SLBs linked to greenhouse gas reductions, an announcement Pfaff described as “stunning”.

Michelle Horsfield, Climate Transitions Manager at the Climate Bonds Initiative, which published its Financing Credible Transitions White Paper last September, said the role of capital markets in decarbonisation must be “ambitious, inclusive and flexible” and that KPI targets would be crucial for heavy polluters to be included in the transition.

As long as a company’s ambition is for zero-emissions by 2050 as outlined in The Paris Agreement, sectors such as steel, cement and chemicals must be included. “Green bonds were great for some sectors, but they left a whole load out,” Horsfield said. “If you look at the seven sectors which account for a third of emissions, we need to get abreast of all of those.”

SLBs, alongside other instruments, will likely play a vital role in providing flexibility in the transition for such sectors, she added.

What about green bonds?

Speakers were, however, keen to stress that the growth in sustainability-linked bonds is unlikely to signal a death knell for traditional green bonds. On the contrary, the two asset classes will likely develop in tandem.

“Where we are going with use-of-proceeds bonds and SLBs is that they serve different purposes,” said Pfaff, who nevertheless said the two formats are “highly complementary” and that issuers will likely consider issuing both types of bonds going forward.

“Where we are going with use-of-proceeds bonds and SLBs is that they serve different purposes”

“There is no reason why [a company] could not have an SLB at organisation level, and then an underlying use-of-proceeds bond on a specific project,” he said. “We talk about products, but we should be talking more clearly about the substance of what transition should be aiming for.”

There is also scope for KPIs to extended beyond the realm of emissions targets, thanks to the flexibility of SLBs. One option, Pfaff suggested, is to have the EU Taxonomy as a KPI, linked to an issuer’s targets regarding EU benchmark guidelines.

Try harder

Such instruments are not without their detractors, with the central criticism of KPI-linked bonds being that they lack ambition on the part of the issuer.

“I get the attractiveness of the KPI model, and conceptually, it’s a beautiful model,” said Manuel Adamini, until recently a Senior Advisor to Climate Bonds Initiative and now a senior responsible investment strategist at BMO Global Asset Management. “But even if you can assess [the KPI’s] relevance, how can you see it is set at the right level?”

“A company has an incentive to make [a KPI target] very realistic, but as an investor you may want to push for it to be very ambitious.”



Manuel Adamini, ESG expert

“A company has an incentive is to make [a KPI target] very realistic, but as an investor you may want to push for it to be very ambitious.”

One obvious example is Total. While regarded as a stronger performer in terms of emission targets compared to peers, its SLB programme is not in fact aligned with net zero, meaning certain ESG investors will not be able to purchases its SLBs.

Adamini also asked whether or not such bonds would have any discernible climate impact, if an issuer lacks the assets with which to issue a use-of-proceeds bond in the first place. “If you don’t have the assets, what is the point in the first place? Will there be climate investments or wider climate impact? If there are no assets, that makes me suspicious, even concerned,” he said.

Stricter enforcement

And then there are the logistical hurdles of bond investing, an issue which applies to both SLBs and traditional green bonds. Not only do investors typically only have a few hours with which to assess a new bond announcement, investors say they are still kept in the dark with respect to alignment of climate goals, governance and reporting.

“We need to have that assurance that what we're allocating capital to is actually delivering what was intended, and that's where we're struggling,” said Faith Ward, Chief Responsible Investment Officer, Brunel Pension Partnership.

“[Currently] you can buy a green bond, but you do not have a huge amount of confidence it will deliver what it should because there aren’t the additional structures around that,” Ward added.

As the market expands and welcomes new issue sectors such as services and industrials, and investors are themselves increasingly tied to Paris targets, the issue of governance – and potentially stricter enforcement measures – will become more pressing.

“Do we need to regulate this? Or do you need more enforcement? I think the temptation is to want to say yes,” said Ward.

Tools such as the Transition Pathway Initiative, an asset-owner led initiative to help asset managers align their investments with the Paris Agreement on which Ward sits as Co-Chair, are invaluable for investors, but more eventually needs to be done to push issuers towards the ultimate goal of net zero.

“Rules sometimes stifle,” Ward conceded. “But I think the spirit of having a stronger governance and oversight, so we make sure that what we have, what we think we're buying, is what we're actually getting.”

Think globally

Key to addressing issues of governance and enforcement, said Michelle Horsfield of the CBI, is first having universal standards, which are agreed upon globally through investor collaboration.

This is where bodies such as the Climate Bonds Initiative and ICMA have a huge role to play, alongside investors, underwriters and NGOs.

“It’s important for investors operating in a global market that the standards are set on a global level”

“It’s important for investors operating in a global market that the standards are set on a global level,” she said, noting that the guidance set out in the Green Bond Principles provide an invaluable reference point.

The Climate Bond Initiative currently certifies around 24% of the world’s green bonds, which Horsfield says provides a quick and recognisable stamp of approval for time-pressed investors.



Michelle Horsfield, CBI

As the market grows, their plan is to address the tricker issues of transition, again, focusing on the biggest emitters. “Our plan is to develop criteria sector by sector,” she said. “Our focus is very much on the big heavies, if you like the industrial sectors like cement and steel.”

But again, collaboration is key when setting standards which big polluters will comply with.

“Crucially, we've got quite a strong contingent of environmental NGOs, who keep our feet to the fire, and make sure it's not just a kind of cosy agreed and easy benchmark,” Horsfield added. “And that we do set criteria that are really robust.”

Supply chains: Don’t pass the buck

Even if issuers are to take the plunge and commit their traditional green or KPI-linked bonds to Paris goals, a crucial issue is the carbon footprint of supply chains.

“I think there is an awful lot of greenwashing going on,” said Manuel Adamini, noting discrepancies in standards from global oil majors, only some of which he said target Scope 3 emission in their reduction targets.

Scope 3 emissions, which include pollution across a company’s entire supply chain, are clearly the most difficult to address, but for actions to have material impact, Adamini said, these emissions must be included.

“Should you start where it’s easy or where its material?” In the end, there is no way around the material stuff,” he added. “We should be very wary of [issuers] telling us about uncertainty.”

Again, this comes back to the issue of common standards, regulation and ultimately, enforcement.

“We need a common reporting standard that is as robust as the current accounting standard,” said Federica Calvetti at Deutsche Bank. “That is the biggest ask for the market right now.”

Is it Just Transition?

On the other side of the coin to supply chain issues lies the even trickier conundrum of the so-called Just Transition – which takes account of the social impact of the move away from fossil fuels.

While the pandemic has triggered a surge in social bond issuance, mostly in the SSA sector, simply recognising the social implications of transition for corporates is only the start of what will be a very tricky compromise.

“When it comes to bedding in the social implications of transition to the low carbon economy, then it gets even more complicated,” said Faith Ward.

While investors cannot ignore the potential unemployment consequences of decarbonisation, Ward said it was also important that the so-called Just Transition is not used as a “mechanism to do nothing.”



Faith Ward, Brunel Pension Partnership

Indeed, the concept could assume a central position in an issuers transition framework. KPIs could for instance be linked to job creation, or retraining staff, Ward suggested.

“We need to guard against it being used as an excuse for doing nothing, but grab it as a positive opportunity for job creation, inclusion and social inequality,” she concluded.

Michelle Horsfield also said the concept provides an opportunity, especially for money managers that are heavily invested in oil and gas.

“The changes that are here are presenting a phenomenal opportunity for capital markets – and they should do what they’ve always done best,” she said. “That is, look at the risks and take the opportunity that is there.”

Activist investors: Stick or carrot?

A key theme that runs through transition is the inevitability that fixed-income investors will play a more active role in holding issuers to account.

“We need to guard against it being used as an excuse for doing nothing, but grab it as a positive opportunity for job creation, inclusion and social inequality”

This begs the question or whether investors should adopt a carrot or stick approach. And what level of accountability should investors bare themselves?

Investors are already facing increased accountability, Ward said, noting that as of last year, disclosure of climate risk is mandatory for big UK companies and financial institutions, which should be reported as outlined in the Taskforce on Climate-related Financial Disclosures.

“There will be increasing pressure on investors to not participate in bond issues unless we can see some really quite specific actions being taken by corporates,” said Faith Ward.

But for investor engagement to be effective, investors need to be more aggressive and more vocal, according to Manuel Adamini.

“I am afraid it is all too slow, too little and too late,” he argued. “Very often engagement programmes are too soft and so benign.”

The same applies for underwriters, Federica Calvetti of Deutsche Bank said. “Clients watch banks and banks watch clients,” she said. “We are trying to navigate a new market and new products, which requires a set of due diligence, scrutiny and reading of data we have never done before.”

But investors are still left wanting, and there is a lack transparency compared to banks. “There is a massive asymmetry of data,” Ward said, referring to discrepancies between information on ESG disclosure available to the sell-side and buy-side respectively.

Pressure on banks will intensify in light of this, with investors increasingly less willing to accept the distinction of lenders who parade their green credentials through green bond programmes, but at the same time have extended loans to highly polluting companies.

“There is a massive ramp up on investor expectation around banking,” said Michelle Horsfield of the CBI.



“From our perspective, issuers are not making the decision to go to the market based on the fact the ECB is there”

Federica Calvetti, Deutsche Bank

Nicholas Pfaff of ICMA however cautioned that in exerting such pressure, investors should not lose sight of the original concept of green bonds, which should continue to function in tandem with newer KPI-linked bonds.

“SLBs are a step in the right direction in terms of providing more information and engaging the whole organisation,” he said. “It is important to underline that originally the concept was you didn’t have to be green to issue [a green bond], [but] segregated green projects [and] still had brown parts of your business. That distinction has been increasingly lost in the debate in the market – and I think that is dangerous, because it erases the history of the product.”

“But there is pressure on issuers to say that what was acceptable [then] is not acceptable now,” Pfaff added. “All issuers of green bonds may need to make a broader commitment.”

The elephant in the room

Although the direction of travel is clear in the bond markets, the push towards green is unlikely to have anything like the effect on issuer funding costs that loose monetary policy has.

However, speakers stopped short of saying that ECB policy has diluted the pool of issuers when it comes to ESG standards.

“From our perspective, issuers are not making the decision to go to the market based on the fact the ECB is there,” said Federica Calvetti of Deutsche Bank. “In the secondary market, if the ECB buys [a bond] it will impact performance, but from an issuer’s perspective, I do not think it’s the primary reason an issuer would tap into the ESG bond market.”

The SLB market had also been growing prior to the ECB’s announcement that it would consider buying such instruments, with a number of deals last – and this – year not CSPP-eligible anyway.

“We have built a market that brings in an extra feature, when arguably you don’t need an extra feature, because any bond likely will be a success,” said Manuel Adamini. “You don’t need [a green label] for liquidity, or for pricing, you probably do it for reputational and strategic reasons.”

And if the policy backdrop is to ever normalise, Adamini said, this will provide “more fruitful grounds for green bonds to really be used as a distinctive feature.”