Investors scrutinize green claims in the $ 80 billion sustainable bond market

The sustainability bond market has exploded to $ 80 billion in issuance this year, even as some investors question the “green” benchmarks of debt that can be used to fund a wide range of initiatives business.

The first deal in this nascent sector did not take place until 2019, but a sign of its growing appeal to companies and their debt holders, global emissions have almost increased nine-fold since late 2020, according to Environmental Finance.

Sustainability bonds do not meet the more stringent criteria imposed on green bonds, where debt is contracted to finance specific green projects. Issuers are not subject to strict restrictions on how the products are used, but rather must agree to certain environmental, social and governance objectives.

Failure to meet these commitments usually results in increased interest payments, which increases borrowing costs for the issuer. But the examples so far suggest that these penalties are relatively weak.

U.S. generic drugmaker Teva, embroiled in the opioid crisis in the United States, recently issued the world’s largest sustainability bond, raising $ 5 billion tied to goals to increase access to drugs in communities. low- and middle-income countries and reduce corporate greenhouse gases. emissions.

If Teva didn’t meet those targets, it would only have to make a fraction of a percentage point in higher payments to investors, which equates to less than $ 10 million in additional annual interest. This additional interest would also only apply after the valuation date in May 2026 for bonds expiring a few years later.

Matt Todd, who analyzed Teva’s deal for rating agency S&P Global, said the penalty was “not significant” for the debt rating. More importantly was the low cost of borrowing achieved through surging investor demand for long-lasting debt. “It’s good for their cash flow,” he said.

Broadly speaking, proponents of sustainability bonds argue that the rapid growth of the market heralds the entry of green debt into the mainstream – allowing companies to make public statements about sustainability that investors can rely on. ‘stick with it, even when they may not have a suitable plan to fund themselves through the more established green bond market.

However, critics argue that such an expansion more reflects less stringent market demands, allowing companies to wave their new ESG commitments without having to do a lot of work to justify them.

“I think sustainability bonds hold tremendous promise,” said James Rich, portfolio manager at Aegon. “But the reality, unfortunately, is that the structures and penalties for not meeting targets are mostly not substantial enough to bring about real and meaningful change among these companies.”

Teva is not an isolated example. The coupon increase on a $ 900 million bond issued earlier this year by Level 3 Financing, a subsidiary of telecommunications company Lumen, was only 0.125 percentage points.

Indian cement maker UltraTech Cement, meanwhile, raised $ 400 million through a 10-year sustainability bond in February. The deal called for a much larger coupon increase of 0.75 percentage points if the company failed to meet certain carbon reduction targets. However, the valuation date falls just six months before the debt matures, making its effect on the company’s interest payments negligible, according to people familiar with the bond.

Investors remain skeptical of the extent to which the sustainability moniker is pushing companies to make meaningful change.

“There is a huge gap between what we need and what we see,” said Charles Portier, portfolio manager at Mirova.

However, others are more optimistic. Scott Mather, in charge of sustainable investments for asset manager Pimco, predicts that the global sustainable bond market – including green bonds, social bonds, sustainability bonds and others – could reach more than $ 10 billion. dollars over the next five years from its current level. of just over $ 2 billion.

Mather also said sustainability debt should be seen as the “big brother” of the green bond market rather than its little brother.

“The fact that companies publicly commit to sustainability goals is powerful,” said Mather. “This creates an expectation among their stakeholders, their customers, their employees and their investors, that they commit to sustainable development. “

These are also the first days, and bankers note that despite a rapid increase in emissions, they are still far from the amount needed to meet demand. Until then, borrowers have the upper hand, which usually means lower borrowing costs and lower penalties.

Penalties aren’t the only thing that matters either, said Anjuli Pandit of HSBC, the lead bank for the Teva and UltraTech deals.

“Investors don’t buy it in the hopes of getting a raise or punishing the company,” Pandit said, noting that more punitive penalties could deter issuers. “This instrument is about companies asking to be held accountable for these goals and providing investors with data to track this. We want that data. We want to open the door between issuers and investors to start this conversation. “

As emissions increase and the balance of power shifts, investors may eventually be able to demand more ambitious targets, demand more granular data, or apply tougher penalties.

However, for now, some investors remain insensitive. “We have seen very few examples that have met our requirements to be eligible for our sustainability-themed investment strategies,” said Rich. “They are just too bland.”

Teva declined to comment. Lumen and UltraTech did not respond to a request for comment.


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