New breed of ESG bonds still risks greenwashing

WITH flexible user proceeds, clear performance targets and legally enforceable penalties, sustainability-linked bonds (SLBs) appear to be a win-win for issuers and investors.

Investors globally have flocked to this emerging class of ESG (environmental, social, and governance) debt on the premise of lower "sustainability washing" risks that have long plagued conventional green bonds.

Still, opportunities for misuse are on the rise amid regulatory grey areas, industry watchers cautioned. SLBs are still in their nascency, having come to the market only in 2019.

"There is no clear framework at the moment, which has led to a lot of ambiguity around SLB targets and how to measure their performance," PC Chakravarti, banking lead and sustainable finance lead at Accenture, told The Business Times (BT).

For investors, it is clear why there appears to be less wiggle room for sustainability washing in SLBs.

Unlike green bonds - where proceeds are ring-fenced for eligible green projects - SLB proceeds can be used for general corporate purposes. In return, issuers must meet a set of key performance indicators (KPIs) benchmarked against pre-defined sustainability performance targets (SPTs).

Missed targets will a trigger a step-up in bond coupon, or a premium on the redemption amount.

Tying bond coupon rates to quantifiable targets offers clear economic incentive for issuers to change their behaviour, said DBS head of fixed income Clifford Lee.

But because there are no restrictions on how bond proceeds are used, money could ultimately go to financing harmful business operations.

As it is, the issuer only has to meet a specific set of KPIs that is often "self-reported, self-policed and unaudited", which increases the risk of sustainability washing, S&P analyst Lori Shapiro told BT.

She flagged that KPIs are also unique to each individual issuer, limiting comparability. Issuers to date have been diverse, representing a broad range of sectors including utilities, shipping, construction, fashion, pharmaceuticals and real estate.

Accenture's Mr Chakravarti pointed out that sustainability washing has been exacerbated by the lack of universal standards to determine the terms and conditions of SLBs "fairly and objectively".

"Right now, any terms and sustainability targets set are primarily decided between borrowers and lenders, without the governance or guidance of a universal regulatory body. This invites room for interpretation, and varying criteria and sustainability targets," he said.

Issuers may also rate against these standards differently, and differ in the way they use them.

"Currently, investors only rely on third-party providers and/or on self-reporting by the issuing company - a case of the fox guarding the henhouse," said Mr Chakravarti.

Last June, the International Capital Market Association published the Sustainability-Linked Bond Principles (SLBP) in a bid to formalise best practices associated with SLBs.

There are five key components: selection of KPIs, calibration of SPTs, bond characteristics, reporting, and verification.

An "early rush" of issuances following the publication suggests that the SLBP may already be having an impact, a Moody's report said. Of the US$15 billion of SLBs issued globally to date, US$10 billion has come to market since September 2020.

Though the SLBP has helped create some clarity, the market still remains in the early stages of defining what constitutes robust sustainability targets across different sectors, making it difficult to forecast how rapidly SLB volumes may expand, said Moody's.

For sectors whose transition pathways extend out multiple decades, for example, the selection of credible long-term and interim targets can prove challenging.

"Furthermore, the use-of-proceeds sustainable bond markets have a significant headstart in terms of their size and growth, with strong investor understanding of these instruments and a proliferation of national and international standards supporting further market expansion," said Moody's.

In Asia, the SLB market remains small with just over US$1 billion in issuances last year, compared to US$50 billion of green bonds issued. S&P's Ms Shapiro said SLBs could grow rapidly as a complement to use-of-proceeds issuances if key challenges are adequately addressed.

Ultimately, the SLBP is just an industry guideline - not regulatory obligations that issuers must meet.

For a start, Asean regulators could endorse a group of second-party opinion (SPO) providers defining strict criteria on the data used, and for the approach employed to complete an SLB assessment, said Accenture's Mr Chakravarti.

This would bring transparency to how SLB performance targets are set and whether they are achievable.

He noted that regulators could further develop an "eco label" similar to that of the European Union. This would include a standardised green ratings scale for financial products, such as bonds, mutual funds and exchange-traded funds.

SPO providers could also be monitored in the same way as credit rating agencies, ensuring that providers "act in a fair, transparent, and equitable manner, and legislating an element of liability", said Mr Chakravarti.

The end goal for Asean, he mused, should be a "tiered system" of standards: a global standard, as defined by the UN and global entities like the World Economic Forum, and national standards that are aligned with the global standard.

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