Market players welcome move to tighten standards on sustainability-linked bonds

CLIMATE Bonds Initiative’s (CBI) plan to expand its certification scheme to sustainability-linked bonds (SLB) will tighten up market standards, but whether they will be widely adopted remains unclear, market observers told The Business Times.

CBI, whose widely referenced standards only cover use-of-proceeds green bonds at the moment, this month launched a consultation exercise on plans to provide certification for SLBs and the corporations that issue them.

Unlike green bonds, SLBs allow issuers to use their proceeds for general corporate purposes. But SLB issuers are subject to mechanisms that can affect the bonds’ coupons depending on whether the issuers can meet sustainability key performance indicators (KPIs). For instance, an SLB’s coupon could step up to a higher rate if the issuer fails to reduce its greenhouse gas emissions after three years.

Taking aim at the level of ambition in those targets, CBI’s plan is to certify only SLBs and entities that are aligned with the Paris Agremeent, or will be by 2030. This means they should be on pathways to limit global warming to 1.5 degrees Celsius by 2050. 

Since SLBs may be used for entities and projects that are not already “green” by existing standards, if the proposal is accepted after the consultation ends on Nov 4, it would also mean that the range of sectors eligible for certification would also be widened to include a number of high-emitting sectors, such as cement, chemicals and steel.

CBI’s proposal seeks to address a common criticism that some SLB targets lack credibility and ambition due to the lack of target standardisation, which has hindered the growth of the SLB market.

Current standards allow for “a fair bit of manoeuvring space” for companies when setting targets, said Martijn Hoogerwerf, head of sustainable finance in Asia-Pacific at ING Bank.

Henry Loh, head of Asian credit at asset management firm abrdn, noted that some of the penalties for failure to meet targets have also been insignificant.

Nneka Chike-Obi, director and head of environmental, social and governance (ESG) research at Sustainable Fitch, an ESG ratings provider, pointed out that the lack of materiality is one of the main problems with SLBs, as many issuers come to the market with KPIs that are not significant enough in the context of their main economic activities.

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Explaining the motivation behind its proposed expansion, CBI said that corporate-wide financing and SLBs are in their early years and the lack of direction has threatened its integrity. It is seeing major greenwashing concerns in the burgeoning market, especially when it comes to the ambition levels of the KPIs being set. 

The expansion of the certification scheme would bridge the gap between existing market guidance tailored specifically to SLBs, which have good uptake but are lighter touch in detail, and the deeper company-level assessment frameworks available that are more comprehensive but perhaps too complex for wide market uptake, said CBI. 

“The certification rules for transitioning entities and SLBs aim to address concerns of issuers and investors on the burden of information and reporting requirements, while maintaining robustness and quality,” read the organisation’s draft proposal.

Since SLB principles by the International Capital Market Association, which are the main market guidelines for these bonds, do not require that the targets issuers set have to be Paris-aligned, observers say that the CBI’s plans to certify those that should help improve market guidance and expectations, enhance the credibility of SLBs, and ultimately, help grow the market. 

Investors would be provided with a benchmark to discern the ambition and quality of a climate-related KPI, which may help boost their confidence to participate in future SLB offerings that have been certified. 

However, the growing number of methodologies measuring company target alignment towards 1.5-degree pathways could open it up to potential confusion and discrepancies, said Miranda Carr, head of applied ESG and climate research at investment research company MSCI.

Given that investors and issuers may be developing company emissions targets that are aligned to several of such accreditation, more work in comparing CBI’s criteria to similar existing frameworks may be beneficial, she added.

While investors and analysts are eager for more rigour, whether issuers will see the value in going for certification is another question, said Kevin Ranney, senior vice president of corporate solutions at Sustainalytics, an ESG ratings agency. 

To begin with, the use of CBI’s certification scheme for green bonds is still not extensive among issuers. It also does not certify other use-of-proceeds bonds, such as social and sustainability bonds. 

Chike-Obi noted that green bonds certified with CBI standards represent a minority of the overall green bond market at around 13 per cent. The cumulative issuance of CBI certified bonds was US$200 billion at the end of 2021, compared to US$1.5 trillion cumulative of green bonds issued.

“It is an optional certification that some issuers pursue to indicate their green commitments,” she noted. SLB issuers that have targets relating to social and governance performance would also not see a need to be certified, as these KPIs are not relevant to the Paris Agreement.

On top of that, the pool of companies with emissions targets as stringent as the certification requires could also likely be small, especially within the Asia Pacific and emerging markets, said Carr.

At a global level, MSCI ESG Research estimates that only 11 per cent of companies are aligned with a 1.5 deg C temperature rise in June 2022.

“Thus, although the SLB market still likely to expand further within Asia-Pacific, the risk is that the uptake of this particular certification in Asia-Pacific could be slower than elsewhere,” Carr said.

Some observers expect that changes to the scheme would not have any immediate impact on the demand and supply of SLBs in this region, while Chike-Obi felt that any effect could only be determined by how widely adopted the standard is in the SLB market.

Nonetheless, the number of SLB offerings in Asia is expected to grow. In fact, Ranney said that he expects the SLB market to grow substantially, with or without CBI’s certification.

*Amendment note: Miranda Carr’s designation was incorrect in the earlier article.