The Green Bond’s Awkward Kid Brother Enters the Market
Sustainability-linked bonds could help finance the transition of carbon-heavy companies, but only if the issuers are serious about climate.
The green bond market is on fire, channeling record funds into climate-friendly projects around the globe — and at a relatively low cost to issuers. Green bonds offer a promising synergy between investors with trillions of dollars chasing ESG products and the need for climate finance, especially in developing countries where access to affordable debt is essential to install those solar arrays, wind turbines and other infrastructure to underpin a new green economy.
But there’s another piece of the puzzle: Can we also funnel money into the transition of carbon-intensive industries to support their transition to a clean economy, breaking the addiction to fossil fuels? In a perfect world, this is where a newer product, Sustainability-Linked Bonds (SLBs) could play a role.
SLBs are still very much a work in progress. So it’s fair to ask: When a global coal developer raises $300 million through an SLB, does it really help finance the transition, or just raise cheap capital to continue business as usual? More on that real-world example shortly, but first, some background.
Most green bonds are labeled “green” by virtue of their use of proceeds — predetermined projects that mitigate or build resilience to climate change. High-quality green bonds typically align with one or more of the predominant green finance frameworks, which lay out what qualifies as green, along with verification and reporting standards.
This is a hugely successful model for funding green infrastructure. So far in 2021, green bond issues have hit nearly $356 billion globally, compared to about $300 billion for all of 2020, according to the nonprofit Climate Bonds Initiative (CBI). And with asset managers of trillions of dollars seeking investments to green their portfolios, green bond issues will likely hit $1 trillion annually by 2023, perhaps even in 2022, according to Sean Kidney, CEO and founder of CBI.
Flying the Plane While Building It
The SLB market, with its first issue in 2019, is just taking off — hitting issuance of $32.9 billion in the first half of 2021, up from zero in the same period of 2020. It’s tiny compared to the whole labeled bond market, but growing fast.
Sustainability-linked bonds, not to be confused with sustainability bonds, raise funds for general use rather than pre-specified projects. And SLBs are structured so that the yield is linked to the issuer’s ability to meet climate transition goals or “key performance goals” such as certain carbon emissions reductions that are set by the company. If the company fails to meet these KPIs, they agree to pay a higher yield, say 25 or 30 basis points more, to bondholders.
In essence, the issuer pays less for capital if they meet their climate targets. Raising money in this way creates an incentive toward sustainability for companies that are just beginning the transition process, especially in hard-to-abate sectors.
Even though the market lacks a set of standards for setting performance goals, verification and reporting, there is a growing number of SLB issuers raising money, and some are certainly raising eyebrows.
Having It Both Ways
Back to that coal giant, Adani Group, based in Ahmedabad, India. In July, Adani Electricity Mumbai Ltd. (AEML), a utility under the conglomerate’s transmission subsidiary, raised $300 million through an SLB.
AEML’s bond lays out an ambitious plan, with short-term key performance indicators (KPIs) to increase the renewable energy in its portfolio to 30% by 2023 and then to 60% by 2027, from a current level of 3%. It maps its goals to U.N. Sustainable Development Goals and the Paris Agreement and stipulates step-ups in the coupon rate if the company fails to meet its goals.
The issue was “oversubscribed 9.2x by high-quality real money global investors …” the company press release trumpeted. Impressive right?
But in the bigger picture, not so much, according to Tim Buckley, an expert on the energy market in India for the Institute for Energy Economics and Financial Analysis (IEEFA). In his view, a sustainability-linked bond in a green subsidiary merely frees up capital for Adani Group as a whole to continue business as usual – and that business is building coal capacity at an alarming rate.
The conglomerate, under patriarch Guatam Adani, has six listed companies. While one company, Adani Green, is an aggressive leader in installing renewable energy infrastructure in India, another is profiting from coal imports, Adani Ports, and yet another, Adani Enterprises, is perhaps the biggest private developer of new coal capacity in the world. Adani Transmission supports both the renewable and the fossil-fuel sides of the business.
“Practically, the conglomerate runs as a single group,” with Guatam Adani as controlling shareholder and chairman of all six listed companies in the group, says Buckley. “They have intercompany loans left right and center. They have intercompany transactions left right and center. They have behind-the-scenes unsecured, undisclosed loans left right and center and they transfer assets willy-nilly just to facilitate the greenwash.”
SLBs: The Promise and the Limits
There are climate finance forces at work to create order and consistency in the SLB market. One challenge is to allow flexibility so hard-to-abate sectors can access financing for a transition to a cleaner business model, without leaving the door wide open to greenwashing. Another is to require goals or KPIs that are sufficiently ambitious without being unreachable. It’s a fine balance.
SLBs as they currently exist also present another major problem: They seem to reward investors with higher returns when the company they invested in fails to reach its climate transition targets. That seems counterintuitive if the goal is to drive investment to climate solutions.
So for now, the SLB market includes an array of the good, the bad and the ugly. While climate finance experts hash out the proper framework for SLBs, green investors are left to scrutinize individual companies to determine their ambition, roadmaps and, perhaps most of all, their sincere commitment to making a transition to climate-friendly business.
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Article by Kari Huus, managing editor for the US Green Bond Review from Climate & Capital Media. She was a long-time reporter for MSNBC.com, with stints covering international business, foreign policy, and national affairs. Earlier, she covered China for the Far Eastern Economic Review and Newsweek in Beijing.