Sustainability-Linked Bonds: Building a High Quality Market

June 17, 2024Published by Climate Bonds Initiative

The ESG credentials of many sustainability-linked bonds are weak and require improvement, says this Climate Bonds Initiative (CBI) report. The authors identify regulatory changes needed for a credible and impactful sustainability-linked bonds (SLB) market, including mandatory standards and improved guidance on target calibration. They also propose a dedicated facility to manage penalties and uphold standards.

SLBs are a type of debt instrument where the issuer’s financial terms, which can include both penalties and rewards, depend on whether they achieve pre-set sustainability goals. These goals are measured by key performance indicators (KPIs) and sustainability performance targets.

“Low-quality SLBs threaten the market’s ability to deliver meaningful improvements in sustainability performance,” the report says. The “considerable criticism” the SLB market has faced is largely due to deficient structural features, calibration issues and weak transition plans, rather than the sustainability-linked aspect itself.

Using the CBI’s own SLB database methodology, the analysis found only 14% of bonds in the US$279bn market align with the Paris Agreement’s goals. The CBI methodology includes a funnel approach to assess alignment based on criteria, such as whether emissions reduction targets exclude offsets.

The report highlights substantial variation and often poor quality in transition planning among issuers, identifying a need for more comprehensive disclosure of emissions reduction plans and their financial impacts. However, issuers from Latin America demonstrate more advanced practices in this area, scoring highest on the CBI’s transition plan assessment.

The analysis also found reporting is often incomplete, with 10% of SLBs assessed lacking public disclosure of key structural elements like KPIs and targets. Even when these were included, they frequently lacked ambition and excluded material ESG indicators such as biodiversity loss, just transition and air quality.

The “core recommendation” of the report is greater use and development of guidance and rules on SLB structuring and disclosures. A best practices checklist is included which can be used as a roadmap for regulators. 

Key takeaways include:

  • transition plans: require issuers to clearly link SLBs to publicly available transition plans and provide guidance on assessing plan credibility;
  • disclosures: mandate alignment with disclosure requirements like the International Capital Market Association’s (ICMA) sustainability-linked bond principles, ensuring all material information is publicly disclosed;
  • targets: require issuers to align with the CBI’s methodology requirements and provide guidance to ensure targets are ambitious, feasible and science-based;
  • KPI selection: introduce rules linking KPIs to relevant reporting standards and the ICMA’s KPI register. KPIs should be science-based, material and include scope 3 emissions as well as other material ESG indicators;
  • call options: monitor use of early call options to ensure they are not used in bad faith to avoid penalties;
  • assurances: require external assurance covering KPI performance and sustainability reporting

The report highlights the importance of supportive policies like the EU green bond standard and Singapore’s sustainability-linked loan scheme for building a credible market. It also notes that improved data through facilities like the Green Bond Transparency Platform can enhance transparency. 

Other recommendations include greater accounting for external factors in target evaluation and a dedicated SLB facility to manage penalties and enforce standards.

This page was last updated June 17, 2024

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