Attaining net-zero for the planet will be impossible if companies don’t reduce their carbon footprint. Still, the transition journey is complicated and financing can be especially tricky. That is where sustainability-linked bonds can prove useful.
SLBs are a nascent instrument yet in a short time the market has taken off. Asia Pacific saw US$0.2bn of deals sold in 2020, but by last year the volumes had grown more than 70 times to US$15.1bn-equivalent.1
Companies’ interest in sustainable bonds is matched by their popularity with investors. While investors were generally shying away from long-dated bonds in April, Australia-based property investor Goodman managed to sell a $500m 10-year SLB at 185bp over Treasuries, tightening around 15bp from initial thoughts.2
The versatile structure of sustainability-linked bonds is key to their appeal. Unlike green or transition bonds whereby the sustainability component primarily involves the bond’s use of proceeds, SLBs motivate the issuer to meet certain key performance indicators (KPIs), like reducing carbon emissions during the life of the bond otherwise the issuer faces a penalty, usually in the form of a coupon increase.
The verification process necessary to prove whether a company has met its sustainability KPIs also tends to be robust.
“This is a very specific feature on SLBs. In the past, for green, social and sustainability bonds, the post issuance verification was optional for issuers,” said Luying Gan, Head of Sustainable Bonds, Debt Capital Markets Asia-Pacific, Global Banking, HSBC. “However, for SLBs the actual performance on the KPIs is required because of the close link to economic payouts.”
On the recent US$230m bond for Yunnan Provincial Energy, the 5.3% coupon will step up if the company does not increase wind generation or solar power capacity by stipulated amounts by the end of 2023.
Yunnan’s bond, for which HSBC acted as sole green structuring advisor, was the first US dollar bond in Asia Pacific labelled both as a SLB and a green bond (“Double ESG” bond), which strengthened its sustainability credentials and broadened investor appeal.3
Norbert Ling, ESG Credit Portfolio Manager at Invesco Fixed Income Asia Pacific, said that SLBs show a firm commitment by issuers. “In transition situations, SLBs could be more relevant as not every sector is capital expenditure heavy and suited to sell green bonds,” said Ling.” If you look at the consumer sector like supermarkets, these companies are focused on operational expenses rather than project level expenses – and this is where SLBs have a big role to play.”
Nneka Chike-Obi, APAC Head of ESG research at Fitch, agrees that the flexibility of the product is a big appeal.
In my view, SLBs are filling in the space for what could have been transition-labelled bonds because it allows companies to show progress over time,” she says.
With China taking less than seven years from pricing its first green bond to now being one of the world’s largest green bond markets, it is likely that the country will be one of the key markets for sustainability-linked bonds too.
Total volumes for sustainable bonds (including green, social, sustainability and sustainability-linked bonds) in China reached nearly US$500bn in the first half of 2021, 59% higher than the same period in 2020, according to Climate Bonds Initiative. Within this, sustainability-linked bond volumes, onshore and offshore, continued to grow.
“SLBs are a very innovative product that was only introduced to China’s onshore market in 2021, proving how the country is always interested to learn about international developments,” said Tim Yip, Head of Debt Capital Markets, HSBC China. “China’s domestic investor base love the product because it pushes the green finance agenda to a new level.”
In China’s onshore market, the SLB market understandably has its own specific national identity. China’s National Association of Financial Market Institutional Investors worked closely with HSBC to produce the 10 Question and Answers on SLBs released in April 2021, which acts as a market framework.
“The Q&A provides much more emphasis on the Chinese social angle such as poverty alleviation,” says HSBC’s Gan. “It also offers more diversified structures on SLBs including that coupon step-downs be allowed.”
“First and foremost, we need to get issuers to give this product a try,” said HSBC’s Yip. “And then we can finesse the details as the product evolves.”
Structurally, onshore SLBs are rarely longer than five years, and state-owned enterprises (SOEs) in the energy or utility sectors have made up the majority of issuers.
“As the nature of the issuers are mainly SOEs, they have high standards on pricing,” continues HSBC’s Yip. “The challenge is to get issuers to really comprehend that SLBs are a long-term strategic investment because it always boils down to seeing a pricing benefit immediately.”
Showcasing ESG Strategies
Looking forward, Invesco’s Ling also hopes that issuers throughout Asia Pacific issue SLBs not only as a one-off exercise, but along their whole curve.
Time and experience will naturally bring a greater variety of SLB structures, be it an extension of tenors, a greater variety of KPIs or more diverse issuers.
One way to develop the market would be for international issuers to sell SLB Panda bonds onshore in China. This would encourage a greater understanding of the differences of the onshore and offshore markets, says HSBC’s Yip.
Whether onshore or offshore, it is clear that SLBs have the ability to not only act as a pivotal instrument for transition financing but also to give companies the opportunity to commit to and showcase their own ESG strategies.