Sustainability-Linked Bonds (SLBs)

The SLB market has seen strong growth in the past two years as it allows for general purpose finance to be raised and because entities can establish their own KPIs and performance targets. SLBs can be powerful, forward-looking financial instruments when they include KPIs with ambitious performance targets material to the main sources of emissions.

The transition impact of the SLB is intrinsically linked to the credibility of the transition plan and ambition of associated performance targets. Climate Bonds assesses the ambition and credibility of entity transition plans against the framework of its Five Hallmarks which examine the entity’s targets, the feasibility and coverage of underlying plans, transparency, and reporting procedures. Climate Bonds encourages issuers to address all Five Hallmarks and their subpoints in their transition plans to emphasise commitment to net zero (Appendix 1).

The first Hallmark of a credible transition plan are Paris aligned targets. 

These require greenhouse gas reduction targets in the short-, mid-, and long-term, to be inclusive of scope 1, 2, and 3, and to be aligned with a science-based sector specific pathway which will limit global warming to no more than 1.5°C. These sectoral pathways are developed by organisations including the Transition Pathway initiative, Climate Bonds Initiative, and SBTi. 

However, as of November 2022, SLBs with targets designed to address all three emission scopes represented just 14.4% of SLBs captured in the Climate Bonds SLB Data Base (USD29.1bn of the USD201.7bn).

For the avoidance of doubt, any SLB from an agrifood company or oil and gas issuer must include scope 3 emissions. Scope 3 emissions can represent 85-100% of the emissions of such entities. However, just three out of 22 oil and gas SLB deals had included scope 3 targets by November 2022.

The strongest SLBs utilise absolute GHG emission targets, science-based sector decarbonisation pathways, or GHG emission intensity targets with a unit of production as the denominator.

Economic intensity targets can be used but are considered less robust and ambitious than absolute or physical intensity methods. Credible economic intensity targets require a greater annual percentage reduction (7% per year, compounded) and should be calculated using the GHG emission per value added (GEVA) method.

SLBs with GHG economic intensity targets represent USD10.5bn of SLB debt, or about 5.2% of the total SLB volumes to date. None of those currently use the GEVA method, but instead use revenue or units sold as denominators.

The strongest SLBs are clear and consistent in their structure. Investors tend to prioritise stronger structures. Issuers should avoid setting call dates prior to KPI observation dates, step-ups that only kick in at the end of the bonds term, and performance target observation dates being set after the maturity of the bond. Yet, all these things have been observed in SLB structures.

Currently, 8.5% of SLB debt (USD17.2bn) has a first call date before the KPI observation date, with an average of 1.8 years between the first call date and KPI observation date. Thus far, Climate Bonds has witnessed one bond called before its KPI observation date. While callable bonds should be welcomed into the SLB market, Climate Bonds encourages issuers to place first call dates after the KPI observation date or include provisions in legal documentation that apply the coupon step-up if the bond is called before the KPI observation.

SLBs where the step-up may only apply to one or two coupon payments represent 15.1% of total SLB issuance. Encouragingly, step-up structures that apply to five or more payments represent 45.7% of SLB