ESG (Environmental, Social and Governance) investing is here to stay, and so are new instruments to facilitate the global flow of capital into sustainability-linked investments. As global investor demand for ESG-appropriate securities increases, so has the issuance of an innovative new fixed income security – the sustainability-linked bond (SLB).
Sustainability-linked bonds are fixed income securities that, while relatively new to the North American credit market, are forming an asset class that is expected to rapidly grow in the coming years.
Unlike a green bond, where issuance proceeds are typically contractually required to be used for certain environmental or climate-related spending1, sustainability-linked bonds are structured to provide more flexibility around the use of proceeds while also holding issuers accountable to certain ESG-centric performance targets.
As part of a sustainability-linked bond’s indenture, an issuer will typically pledge to meet certain performance-based ESG targets2, while also offering contractual downside protection for investors in the form of interest rate penalties if issuers fail to meet pre-defined sustainability-related performance criteria over time.
Without the limitations on the deployment of proceeds that are typical of green bonds, sustainability-linked bonds may provide corporate borrowers with more issuance capacity given the greater options around the use of proceeds. This flexibility could contribute to significant market growth in the coming years.
In terms of market size potential, the green bond market could reach $400 – $450 billion USD this year, whereas market participants estimate that the SLB market could potentially grow to $150 billion USD in only its third year of existence3. The SLB market is still relatively new, and issuance has initially largely been concentrated outside of North America.
Enel launched the first SLB in September of 2019, and more than 80% of 2020’s issuance was primarily concentrated in the EMEA region2. However, we expect continued market diversification as the global SLB market enters new phases of development – not just from a geographic perspective, but also across industry sectors, including those sectors that remain in the metaphorical ESG “hot seat” like the energy sector.
While energy is typically a heavily debated industry among ESG-focused investors, corporate borrowers with transparent and industry-leading ESG profiles have proven they can also successfully tap this new and rapidly growing SLB market.
Following the June 2021 release of its sustainability-linked bond framework, North American midstream operator Enbridge launched its first SLB in the U.S. This was the first time a North American pipeline operator had priced an SLB in the U.S., and it was swiftly followed by a second successful SLB transaction in Canada.
Enbridge proactively provided a transparent overview of the company’s sustainability-linked bond principles and targets, paving the way for two successful bond deals and giving the company the “first-mover” advantage in the North American energy space with respect to SLB issuance.
Given Enbridge’s two successful transactions, one in the U.S. and the other in Canada, we expect more issuers across both geographies and industry sectors to continue evaluating SLBs as a permanent part of their future funding strategies – a trend that we expect may provide a variety of potentially new and interesting investment opportunities for global sustainability-focused fixed income investors.
1 Source: Morningstar, What are Green Bonds?, June 17, 2021
2 Source: S&P Global Market Intelligence, Sustainability-linked bonds in ‘rapid growth’ as more firms tap ESG debt market, June 23, 2021
3 Source: Reuters, Sustainability-linked bond market to swell up to $150 billion: JPMorgan ESG DCM head, March 22, 2021