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A file photo of an unauthorized steel factory in China’s Inner Mongolia from 2016. Photo: Getty Images

Green finance: Sustainable Fitch finds some sustainability-linked bonds’ ESG benefits fall short of investors’ expectations

  • Only 47 per cent included a KPI considered core to their business under ICMA’s KPI registry, study finds
  • Quality of KPIs is crucial because if they are set too loosely, they won’t be meaningful for tracking issuers’ participation in sustainable activities, First Sentier Investors executive says

Issuers of sustainability-linked bonds – a fast-growing tool for financing decarbonisation projects and meeting climate goals – have fallen short on setting performance benchmarks, according to a study.

After reviewing deals concluded between 2019 and mid-2020 by the world’s first 30 sustainability-linked bond issuers and their bonds’ key performance indicators (KPIs), analysts at data and ratings provider Sustainable Fitch found that only 47 per cent included a KPI considered core to their business under the International Capital Market Association (ICMA)’s KPI registry. Some 20 per cent had a KPI deemed secondary.

Another 18 per cent had a core KPI that was only partially fulfilled, such as reducing only greenhouse gas emissions from sources owned or controlled by the issuers, while the recommendation is to also include emissions from activities not under their control, such as consumption of their products.

“The data indicates that while some issuers have ensured relevance in their KPI selection, many others still need clarification,” said Nneka Chike-Obi, head of Asia-Pacific ESG research at Sustainable Fitch. “This is especially important for non-emissions targets in cases where companies are looking into the effect of other environmental and social factors on their business.”

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The study’s findings are significant because the issuance of global sustainability-linked bonds jumped more than tenfold to US$91.2 billion via 154 deals last year from US$8.3 billion through 16 transactions in 2020, according to financial data provider Refinitiv. So far this year – up to last Friday – issuances worth about US$52.9 billion were recorded.

In Asia-Pacific, the growth was more than 100-fold, to US$9 billion last year from US$67 million in 2020. Some US$4.5 billion was registered so far this year.

Chinese green bond issuers need to improve post-issuance disclosure: report

According to the Sustainable Fitch study, about 15 per cent of the issuers had KPIs that are neither core nor secondary. Examples include targets on cutting sulphur oxide instead of carbon dioxide emissions, and investing in non-green but lower-emitting vehicles. The findings suggest that in certain sustainability-linked bond deals, the environment, social and governance (ESG) benefit may not be as big as investors expect.

In mid-2020, ICMA published a set of voluntary principles for the issuance of sustainability-linked bonds, when they were a relatively new debt instrument. Green bonds, which finance activities that have environmental benefits, have a history of 14 years.
Unlike green bonds, whose proceeds must be used on specific projects, sustainability-linked bond issuers face no such restriction. Cumulative sustainability-linked bond issuance reached 10 per cent of the global sustainable bond market this year, up from 1 per cent in 2020, according to Sustainable Fitch.

Sustainable bonds boom as investors demand climate change commitment

To motivate issuers to achieve sustainability goals, most sustainability-linked bonds have a penalty for missing performance targets, typically a 25 basis point – 0.25 per cent – increase in the bonds’ coupon rate.

With no restriction on use of proceeds from sustainability-linked bonds, the quality of KPI setting is key to achieving sustainability goals, said Fiona Kwok, portfolio manager at First Sentier Investors.

“Quality of KPIs is a concern to us, because if they are set too loosely, they won’t be meaningful [for] tracking issuers’ participation in sustainable activities,” she said. “At the same time, investors are prone to greenwashing risk.”

Concerns over ‘greenwashing’ hit credentials of sustainability-linked bonds

To address this, ICMA added a KPI registry in June this year, which gives 300 illustrative examples of KPIs covering 22 sectors and a “materiality matrix” to help identify the relevance of key sustainability themes.

While this should help investors identify how material the KPIs are to the issuers’ core business, issuers are not required to explain how they will achieve the targets, Sustainable Fitch’s Chike-Obi said. “This means that even if the KPIs are more material, there is still the risk that they are not in a position to actually meet the targets,” she said.

Tying coupon step-up with issuers’ credit and ESG ratings, and giving investors the right to sell the sustainability-linked bonds back to issuers when they fail to reach their ESG targets would help address these concerns, said First Sentier’s Kwok.

Sustainability-linked debt financing tripled in first half of 2021. Here’s why

With assets worth US$149 billion under management in June, the Sydney-based firm has a target of having a quarter of its Asia fixed-income portfolio aligned with a net-zero emissions pathway and the remainder in the process of doing so, by 2040.

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