Roughly a quarter of all euro corporate bond issuance year-to-date has been related in some way to meeting environmental, social and governance (ESG) targets, i.e., it has come with green, social or sustainability label or is sustainability-linked.
Data providers categorize issuance differently. (Now there’s an industry crying out for standardization!) But between €300 billion and €400 billion euros (US$356-475 billion) of corporate bond supply so far this year is nominally contributing to ESG projects (mostly refinancing) or has ESG-related key performance indicators (KPIs) holding issuers to targets under pain of higher credit margins. A similar trend can be seen in the sustainability-linked loan market.
The marketing benefits and other attractions of being seen as contributing to the green finance revolution as an investor or lender are clearly very high. On the bond side, we know that ESG issuance can attract a bigger investor crowd than conventional issuance for the same issuer. That’s because sticky ESG buy-side money will pile into order books and stay there until the pips squeak while conventional funds will reasonably go elsewhere to get better compensated for the same risk.
On top of that, a lot of bond investors arbitrage euro bond market technicals by putting orders into new-issue books just so they can free-ride the European Central Bank bid regardless of whether or not they like the credit or even the price. On that basis, I’m sceptical about all of that chatter about greeniums in this environment. At best, if there is a greenium, it’s not necessarily (or at all) because of a bond’s ESG credentials.
Lively ESG bond activity has, though, potentially strengthened the hand of bond investors. The beauty of a crowded market for labelled new issuance is some investors can play hardball on issuers whose ESG bonds have flaky or unconvincing ESG impacts or which lack stretch KPIs.
If the leading asset managers and asset owners threaten debt denial for wayward issuers or at least pressure them to strengthen their ESG targets, it will likely force companies to up their game on project selection, impact and target-setting. The beauty of choice means investors can do that on the basis that if they refuse to go into one ESG order book, there are a dozen others at any one time that they can invest in where issuers will be more compliant around stewardship efforts.
On the flip side, though, dedicated ESG investor pools are growing quickly and a lot of that money is taking a tick-box approach and won’t apply or lacks the resources to apply rigorous research on the flood of issuance hitting the market. The timeline for issuing bonds is so short that once an issuer announces a mandate, it is already too late to conduct the required scrutiny.
I was drawn to this issue of competition in green finance and its potential downsides not just in the bond market but also by something I read about certain issuers of sustainability-linked loans (SLLs). The sustainability-linked loan market has been gathering pace for two to three years now and its visibility has increased as large corporate issuers trumpet new SLL issuance or upgrade existing facilities to make them sustainable. That’s all good.
But what I found extraordinary is I gather some issuers have gotten their SLLs signed before lenders have even seen the KPIs. That’s not to say the KPIs won’t be reasonable and that all will eventually be fine. But what goes through lenders’ minds when they sign up to take a slice of these loans? Flying blind on ESG targets has to be a one of the most absurd and imprudent developments in the green finance market – if the intention is to contribute in a meaningful way to sustainability.
Schlumberger reportedly got its €750 million sustainability-linked revolving credit facility over the line this month but won’t, I read, present formal KPIs for months. And even then the company won’t circle back to lenders to gain the thumbs up. Sanofi (€2.5 billion) and Michelin (€8 billion) reportedly also signed loan facilities before full disclosure. What message does that send to companies? The obvious one is that they can dilute their KPIs because they’ve already got the money signed off and can still shout their sustainability achievements from the rooftops. It’s a truly dreadful precedent.
It’s fabulous that so much corporate bond and loan issuance has an ESG angle. But it would be a massive market own goal if the deluge of new issues and the inability of most lenders and investors to process the required information to make informed decisions and select opportunities with most sustainability bang for the buck – if they have information at all – were to lead to an erosion of standards. That would do nothing more than raise the spectre of that word that market participants love to hate – greenwashing.