Need to finance the transition to a sustainable economy
To finance a sustainable future, we need significant investments to achieve the Sustainable Development Goals. The SDG financing gap was estimated at ca. USD 2.5 trillion annually before the pandemic. Due to Covid-19, the unmet SDG financing needs could increase by 70%.
Sustainability-linked bonds (SLBs) offer an opportunity to fixed-income investors for investing in a sustainable future. A bond is like a loan that you give to a government or a company. The difference is that the debt can be traded. As a bond investor, you will get a coupon, which is an interest payment. The interest rate will be paid by the issuer of the bond and can vary depending on markets, risks, and duration.
In the case of a sustainability-linked bond, the financial characteristics can vary depending on whether the issuer achieves predefined sustainability objectives or outcomes. In that sense, SLBs are performance-based instruments, where bond issuers commit to future positive sustainability outcomes within a defined timeline. Those objectives are measured through Key Performance Indicators (KPIs) and assessed against predefined Sustainability Performance Targets (SPTs).
Sustainability-linked bonds contribute to achieving the SDGs
The risk profile of sustainability-linked bonds is not identical to that of a conventional bond from the same issuer. #SustainabilityLinkedBonds are forward-looking performance-based instruments.
While the proceeds – that is, how the firm, government, or organization intends to utilize the money raised from investors – can be used for general purposes, sustainability KPIs play a key role in bond characteristics. Penalties, such as a coupon increase, are usually defined in case the sustainability predefined targets are not achieved. Such penalties constitute a financial incentive for the issuers to reach their targets. The KPIs used may include factors such as a defined amount of CO2 emissions, water use or the percentage of women in management.
Thus, investing in sustainability linked bonds ensures that the issuer has set itself specific sustainability targets, thereby contributing to reach one or several of the 17 SDGs. For example, a supermarket brand can have food waste reduction as well as percentage of healthy products sold and carbon emission reduction as its predefined sustainability performance targets. In this example, the achievement of the sustainability targets contributes to reach SDG 12 “Responsible Consumption and Production” as well as SDG 3 “Good Health and Well-Being” and SDG 13 “Climate Action”.
While there is yet no legally binding definition of what sustainability-linked bonds are, some principles and guidelines have been developed such as the Sustainability-linked Bond Principles of the International Capital Market Association (ICMA).
How radicant selects sustainability-linked bonds
The sustainability-linked bonds market is very recent and has quickly developed. To guarantee that we invest in sustainability-linked bonds funding projects that truly contribute to the achievement of the SDGs, we intend to invest in bonds classified as “Sustainability-linked” on the ICMA database. The Sustainability-linked Bond Principles recommend that issuers report on the use of proceeds and more and more issuers follow these guidelines.
In addition, many issuers obtain a second opinion for their sustainable bonds from research agencies such as ISS ESG, Sustainalytics or Vigeo Eiris.