When luxury fashion brand Chanel issued 600 million euros in bonds last September, there was an unusual trap: If the company does not meet its sustainability goals, it will have to pay penalties to investors.
The deal is an example of a new type of debt known as the sustainability bond, which is a way for companies to finance themselves while also tying repayments to their sustainability goals. This is different from traditional green or sustainable bonds, where the money raised must be spent on a specific green or social project.
“Sustainable development obligations essentially help companies create an ambitious and responsible path to support their overall sustainable development strategy,” explains Delphine Queniart, Global Head of Finance and Sustainable Solutions at BNP Paribas Global Markets.
The sale of Chanel bonds consisted of two separate transactions of 300 million euros each. The first commits the company to halving its greenhouse gas emissions by 2030 and reducing its supply chain emissions by 10%. The second commits to switching to 100% renewable electricity in all of the company’s operations by 2025.
If Chanel fails to meet its emissions targets, it will have to pay a 0.75% cash penalty, almost doubling the 1% interest rate it pays to borrow the money. Likewise, if it fails to meet its renewable electricity target, it will have to pay an additional 0.5 percent premium on top of the 0.5 percent interest rate for that bond.
In addition to emissions targets and renewable energy targets, some issuers have included diversity targets. Schneider Electric’s agreement in November 2020, for example, included a goal of improving gender diversity in all of its activities so that by 2025 women represent half of all new hires, 40% of managers. frontline and 30% of its management teams. It is also committed to training a million disadvantaged people in energy management by 2025.
“A few years ago, it was not so easy to hold companies to account and monitor their ESG [environmental, social and governance] improvements, but sustainability bonds will help you do that, ”says Mark Munro, fund manager at Standard Life Investments. “These will help move the conversation forward; it is much better to think of an overall ESG objective for a company rather than a specific project.
Italian energy company Enel issued the first sustainability bond in 2019, taking inspiration from the loan market where interest rates could be raised or lowered depending on whether certain measures had been met or not. This remained the only deal until last year, when the introduction of the International Capital Market Association’s Sustainability Bond Principles, which provide guidance on how bonds are to be structured, was introduced. prompted more businesses to follow suit.
Chanel, Novartis and Suzano! all bonds were issued in September 2020, and further transactions followed in November after the European Central Bank said it would accept sustainability bonds as collateral.
In total, companies issued around $ 9 billion in sustainability bonds in 2020, according to Ángel Tejada, head of the green bond group at Spanish bank BBVA. He thinks there could be anywhere up to double that amount issued in the coming year.
“We’re likely to see issuers trying to supplement their green bonds with sustainability bonds because they offer more flexibility and fewer limitations on what they can spend the proceeds on. But we are also likely to see new issuers who are not in a position to fund enough qualifying assets to issue a green bond, but who wish to engage with ESG investors, ”Tejada said.
Tesco was one of the first companies to tap the market this year, issuing a € 750 million sustainability bond in January that commits the supermarket chain to cut greenhouse gas emissions by 60%. greenhouse by 2025.
While bankers predict that the volume of sustainability bond issuance could potentially match the green bond market, which Dealogic said saw $ 235 billion in transactions last year, they also warn of a shift. too fast.
“It is important for us to know how these bonds are structured, that the objectives are ambitious and credible so that there is no greenwashing,” said Queniart at BNP Paribas. “We prefer there to be a thoughtful pace to shape the market, rather than people who quickly set unreliable goals, which can erode confidence in the emerging market.”
Reputational risk could also dampen potential emissions since if a company did not meet its sustainability goals, it could attract negative publicity and discourage others from making deals.
“If you set high goals for yourself and miss them, and then get criticized for it, it will ultimately hurt market development,” says Clare Burgess, Partner at Clifford Chance.
Some companies also question the value of rewarding investors for missing goals. For example, Hong Kong’s real estate group New World Development issued a sustainability bond earlier this year, which instead of paying investors a higher interest rate if it doesn’t meet its target , will spend the equivalent amount to buy carbon offsets.
While it is too early to assess the impact that sustainability bonds will have on broader efforts to achieve net zero emissions by 2050, market development is part of a larger ESG trend that is redefining the way people invest.
“The real deciding factor is how much more thoroughly and holistically ESG and sustainability criteria are integrated into investment strategies,” says Andrew Carey, Group Co-Head of Impact Financing and Investing by Hogan Lovells. “What is potentially much more powerful than the bonds themselves is the more radical shift in the way investors think about sustainability.”
This deeper ESG focus among investors is also likely to change the way companies approach sustainability.
“As we have seen with green finance in general, the real benefit is that it elevates sustainability issues to the level of the treasury function and the board of directors, as it is no longer just the territory of the corporate responsibility group, ”says Burgess. “It allows people to talk to each other and it creates the momentum behind sustainability changes in the business, which can have a much bigger impact. “
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