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Two Steps Forward

The rise (and rise) of sustainability-linked finance

When the cost of money is tied to a company’s sustainability performance: Game on.

Sustainability finance

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One silver lining of this horrific moment is the rise of loans, bonds and other financial instruments linked to sustainability outcomes. In this sense, "sustainability" is broadly defined to include environmental issues as well as social ones. And, more recently, a new subcategory of, yes, pandemic-related issues.

Indeed, the pandemic response is being financed in part through bonds designed to fund development of vaccines or treatments, support healthcare systems fighting the outbreak or provide relief efforts, such as for cities and counties facing budgetary challenges due to lost revenues and emergency spending. As of the end of May, governments, banks, companies and others raised just over $150 billion globally from selling pandemic bonds, according to research by BNP Paribas, as reported by the Wall Street Journal.

"These instruments will contribute to the economic recovery of many sectors and will emphasize socially focused measures targeting specific segments of the population," BBVA, the Spanish multinational financial services company, wrote recently.

When the cost of money is tied to a company’s sustainability performance: Game on.

Pandemic bonds join a growing list of sustainability-linked financial instruments that have been gaining the attention of investors worldwide. The bonds alone come in a veritable rainbow of flavors: green bonds; climate bonds; sustainability bonds; social bonds; ESG bonds; blue bonds (related to oceans); and more. Last month, German company Henkel, which specializes in chemistry for adhesives, beauty care and laundry products, issued a "plastic waste reduction bond" to fund projects related to the company’s efforts to reduce packaging waste.

There are, no doubt, other flavors, with more to come.

And yes, each of those flavors has a more-or-less specific purpose. Green bonds are used to finance projects and activities that benefit the environment. Sustainability bonds are used to finance projects that bring clear environmental and social benefits. Social bonds are aimed at achieving positive economic outcomes for an identified target population, with neutral or positive impact on the environment. (Nasdaq offers definitions and criteria for each type of bond here.)

By whatever name, money is pouring in. Last week, Moody's Investors Service raised its forecast for 2020 sustainable bond issuance to as much as $375 billion, a category that includes green, sustainability and social bonds.

Companies are jumping in with such regularity that it is rarely newsworthy anymore, except when it is. A few examples from 2020:

  • In February, Verizon’s green bond drew orders equivalent to eight times the $1 billion the company sought to raise. "Within 25 minutes, orders had already exceeded the $1 billion mark," said James Gowen, the company’s vice president and chief sustainability officer. By that afternoon, more than 300 investors had ordered more than $8 billion in debt.
  • Also in February, investment firm Neuberger Berman announced a $175 million sustainability-linked corporate revolving credit facility, the first North American financial services firm to do so. The loan will be benchmarked annually against several criteria, including that the company maintain an "A" rating or higher for its ESG integration on each module for which is scored by the United Nations-supported Principles for Responsible Investment.
  • This month, Visa issued its first green bond, totaling $500 million, to be used to fund energy-efficiency improvements, expanded use of renewable energy sources, employee commuter programs, water efficiency projects and initiatives that support the United Nations Sustainable Development Goals.

But the big kahuna of bond sales took place earlier this month, when Alphabet, the parent of Google, issued $5.75 billion in sustainability bonds, the largest sustainability or green bond by any company. (It was one part of a larger, $10 billion bond offering.) The proceeds are intended to fund a laundry list of initiatives, including energy efficiency, clean energy, green buildings, clean transportation, circular economy products and processes, affordable housing, purchases from Black-owned businesses as well as from small and midsized companies, and to support "health organizations, governments and health workers on the frontlines."

Like a growing number of bonds, Google’s hew to the Green Bond Principles and the Social Bond Principles, both promulgated by the International Capital Markets Association.

Loan arrangers

It’s not just bonds. Sustainability-linked loans — sometimes called ESG-linked loans — are also garnering interest. Last year, the issuance of sustainability loans (which includes social as well as green loans) jumped 168 percent to $122 billion, according to BloombergNEF.

Sustainability-linked loans may sound similar to the similarly named bonds described above, but they’re not. Rather than raising funds for a particular category of projects or initiatives, the proceeds of sustainability-linked loans can be used for general business purposes. However, their interest rate is tied in part to the borrower’s sustainability performance. It requires the borrower to set ambitious and meaningful "sustainability performance targets" and report regularly — at least annually — on its progress, ideally with independent verification.

Such loans have a built-in pricing mechanism, in which the interest rate drops if the borrower achieves its goals; it may rise if the goals aren’t met.

So far, 80 percent of sustainability-linked loans have been made in Europe, although the practice is expanding in other countries.

One company took out a loan for a renewable energy project, with the interest rate linked to the company’s gender equality performance.

Late last year, building controls company Johnson Controls linked the pricing of a $3 billion line of credit to its ESG performance. The deal was underwritten by a consortium of 18 major banks, including JPMorgan Chase, Bank of America, Barclays and Citibank. The sustainability performance targets are tied to employee safety and to greenhouse gas emission reductions from customer projects as well as from Johnson Controls’ own operations.

In February, JetBlue Airways announced a sustainability-linked loan deal with BNP Paribas, the French banking group, amending an existing $550 million line of credit. The interest rate is tied to the airline's ESG score as calculated by Vigeo Eiris, a U.K.-based provider of ESG research and services.

In yet another case, one company took out a loan for a renewable energy project, with the interest rate linked to the company’s gender equality performance, according to Mallory Rutigliano, green and sustainable finance analyst at BNEF.

All of this is expected to continue to grow, with no apparent ceiling, as various types of instruments gain popularity based on a combination of hot-button issues and a hedge against risk.

For example, it’s probably not surprising that in today’s climate of social and racial inequities, not to mention the pandemic, social bonds are currently a hot property. According to S&P Global, "We expect social bonds to emerge as the fastest-growing segment of the sustainable debt market in 2020. This stands in sharp contrast to the rest of the global fixed-income market, for which we expect issuance volumes to decline this year."

As with any growing market, there’s a need for standardization of definitions and metrics. But that’s inevitable. For now, let’s celebrate that financial institutions are — finally — beginning to hold companies accountable in ways that can directly affect their their bottom line.

And when the cost of money is tied to a company’s sustainability performance: Game on.

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