MORE and more companies are selling sustainability-linked bonds — but investors should take care issuers are genuinely making changes and not simply greenwashing, says Pendal’s Murray Ackman.
Sustainability-linked bonds are debt securities that pay a coupon linked to the achievement of environmental or social outcomes.
Importantly, these “SLBs” are not linked to a specific project. They instead allow an issuer to set an overarching goal such as reducing emissions or improving diversity at a corporate level.
If an issuer fails to hit its goal, usually it pays a penalty in the form of a higher coupon.
“In theory, they are great — but we’re starting to see some things we are not happy about with these structures,” says Ackman, a credit ESG analyst at Pendal.
“We want to make sure that sustainability-linked bonds don’t turn into greenwashing because that will muddy the whole market,”
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Sustainability-linked bond issuance reached US$103 billion last year — a one-year increase of 803 per cent, according to World Bank research.
That makes SLBs the fastest-growing sustainable debt instrument — with considerable potential to grow further on the back of strong investor, appetite and supportive government policy.
They are starting to gain traction in Australia.
A leading retailer has issued a bond linked to its move to renewable energy, while a telecommunications company has an issue linked to the rollout of solar panels at its retail stores.
But sustainability-linked bonds have some important flaws that investors need to understand, says Ackman.
Probably the most fundamental flaw is the fact that if an issuer fails to meet the underlying environmental or social goal, the bond no longer meets the criteria to be called sustainable.
This means it has to be divested by most sustainable investment strategies just as the step-up coupon is due to be paid.
“We invest in these SLBs in our sustainable funds — if they don’t meet the target, we get a coupon step-up. But that means the bond is no longer tied to an environmental or social goal,” says Ackman.
“If it is no longer a sustainable bond, we cannot hold it in a sustainable strategy.”
Another emerging flaw is that the typical coupon step-up of 25 basis points made sense when interest rates were next to zero — but it may be less attractive to investors now that the general bond yields are higher.
A third problem is that some Australian companies are issuing bonds that are not sufficiently ambitious in scope.
“The federal government has a target for the grid to be 82 per cent renewable by 2030.
“If you are in a sector that can reduce emissions by changing where your electricity comes from, your corporate target has to be much more ambitious than the grid target.”
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Ackman says it’s the right time for investors to discuss how they want sustainability-linked bonds to adapt because its early days in the development of the product.
“It is still a novel idea and just because it is the way it is now doesn’t mean it is the only way it can be.
“What we are trying to do is safeguard this market.
“That means talking to arrangers before deals are shared and speaking in public forums about the things we’re not happy about with these structures.
“We want to make sure that these this structure doesn’t turn into greenwashing.”
Credit ESG analyst Murray Ackman joined Pendal’s Income and Fixed Interest team in 2020 to provide fundamental credit analysis and integrate Environmental, Social and Governance factors across credit funds.
Murray has worked as a consultant measuring ESG for family offices and private equity firms and was a Research Fellow at the Institute for Economics and Peace where he led research on the United Nations Sustainable Development Goals.
Pendal’s Income and Fixed Interest boutique is one of the most experienced and well-regarded fixed income teams in Australia.
The team’s awards include Lonsec’s Active Fixed Income Fund of the Year (2022) and Zenith’s Australian Fixed Interest Manager of the Year (2020).
Regnan Credit Impact Trust is a defensive investment strategy that puts capital to work for positive change.
Pendal Sustainable Australian Fixed Interest Fund is a defensive Australian bond fund that delivers market-leading performance with positive environmental and social outcomes.
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