The rise and rise of ESG-linked debt issuance

White & Case LLPESG-linked financing issuance swelled in 2021, with issuers responding to the rapid growth in investor demand for environmental and socially-linked debt issuance

Debt issuance linked to environmental, social and governance (ESG) metrics has accelerated at an unprecedented pace in 2021, as issuers move to position their credits to meet swelling investor demand for green and sustainability-linked paper.

According to the Institute of International Finance (IIF), issuance of green, sustainability and sustainability-linked bonds is on track to exceed US$1 trillion this year. Over the first half of 2021, sustainability and green debt sales more than doubled year-on-year to $680 billion. Issuance in 2021 is already close to the full year 2020 total of US$700 billion.

The surge in ESG debt issuance has been underpinned by growing investor appetite for sustainable and green-linked investments. A survey by UK insurer Aviva found that the pandemic influenced the likelihood of taking ESG factors into consideration for 55% of respondents when deciding how to invest. Global funds network Calastone, meanwhile, reports that, in July 2021, ESG vehicles accounted for 90% of inflows into equity funds.

ESG pricing play

The increasing focus on ESG has filtered into debt markets and issuers have recognized that presenting a coherent ESG strategy to investors opens up access to new pools of capital and opportunities to lock in favorable pricing.

Issuance of bonds with sustainability-linked pricing ratchets—where issuers pay a lower coupon on their debt if pre-agreed ESG key performance indicators (KPIs) are achieved (or a higher coupon if targets are missed)—increased nearly four-fold, year-on-year, in the first six months of 2021 to US$160 billion, according to the IIF.

Italian energy group Enel, one of the pioneers in sustainability-linked debt instruments, for example, closed a record ESG-linked bond sale in June with the issue of bonds valued at €3.25 billion (US$3.83 billion).

The deal saw Enel raise the capital across three tranches, with each bond tranche linked to greenhouse gas emissions targets, and coupons increasing by 25 basis points if Enel’s emissions exceed the agreed thresholds. It is the largest sustainability-linked issue on record, surpassing a US$1.85 billion issue from pharmaceutical group Novartis.

Another energy multinational, French-based TotalEnergies, has announced that all of its future bond issuances will be linked to climate emissions KPIs. In other sectors, Global steel company SSAB—which aspires to be the first fossil fuel-free steel producer—issued a SEK 2 billion (US$230 million) five-year senior unsecured sustainability-linked bond due in 2026. The bond bears interest at a rate of three-month Stibor plus 1.85% p.a. and failure to meet certain sustainability performance targets (SPTs) linked to greenhouse gas emissions by 2025 would trigger a redemption premium at maturity. The SPTs align with SSAB’s goal of reducing greenhouse gas emissions by 35% by 2032.

Global growth

Although European and North American issuers have accounted for the bulk of ESG-linked issuance—the IIF calculates that emerging markets only represent 15% of activity—sustainability and ESG debt are rapidly gaining traction and interest across all regions.

In Latin America, Brazilian-based beauty products giant Natura Cosméticos raised a US$1 billion ESG-linked bond that commits the group, which is already carbon neutral, to cut emissions by an additional 13% and secure 25% of post-consumer recycled plastic in its plastic packaging. Failure to meet these benchmarks by 2026 will trigger an increase of 65 basis points to the bond’s coupon.

In Asia, meanwhile, the pipeline for the rest of the year is robust with Japanese real estate group Mori Hills, Chinese real estate company Minmetals Land and India’s Adani Electricity Mumbai all reportedly preparing to bring sustainable and green bonds to market.

In addition to the rising demand from investors, the growth in global ESG debt activity has also been supported by the fact that ESG and sustainability-linked financings can be used for various corporate purposes and are based on specific ESG targets. This is in contrast to green bonds, where the use of proceeds is linked to qualifying green projects.

This has opened the market to a broader spread of issuers, who can raise ESG-linked finance based on their overall ESG performance rather than a limited set of green projects.

Setting standards

As the range of ESG-linked financing options has expanded beyond green bonds, the question of standards has intensified. Some worry that greenwashing and ESG “window dressing” could cloud the distinction between genuine ESG issuance and opportunism.

Standards for ESG-linked debt, however, have evolved rapidly and lenders have found benchmarks on which to base ESG allocations. Europe has led the way, with the EU’s Sustainable Finance Disclosure Regulation (SFDR) emerging as not only a benchmark for European players, but also global issuers and investors.

The SFDR, which became effective on March 10, 2021, requires asset managers to provide investors with ESG information both at a firm level and at the fund/product level using mandatory disclosure templates. And while the detailed disclosure templates are not due to be finalized until July 1, 2022, the market is using the draft templates in the interim. US investors have started to ask that their investments be eligible for certain SFDR criteria, which could see further price differentiation between ESG and non-ESG assets.

The implementation and uptake of standardized SFDR benchmarks gives asset managers and investors confidence in the profile of the ESG-linked investments they are making, reducing the risk of greenwashing. Issuers stand to benefit as well, with the SFDR providing clarity on how to gain traction in the market with investors.

The commencement of the European Central Bank’s (ECB) ESG asset purchase program this year, which includes all types of securities with environmental features, including sustainability-linked instruments based on the United Nations’ Sustainability Development Goals (SDGs), adds further clarity on standards for sustainability and ESG-linked debt products and issuers.

The ECB’s initiative follows the earlier release of a white paper co-authored by White & Case for the G20 Sustainable Finance Study Group, which proposed that central banks across the G20 support the growth of the sustainable finance market by printing new money.

With global institutions and central banks supporting green and ESG-linked financing at greater scale, the credibility of the market will strengthen and give investors the confidence to back issuers of ESG-linked offerings. This bodes well for the future, with the surge in ESG issuance observed this year building into 2022 and beyond as more investors and issuers enter the space.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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