Premiums for sustainable debt instruments only justified by robust and credible structures and targets, ELFA survey finds.
High yield investors are concerned that issuers are reaping lower fundraising costs from sustainability-related bond and loan structures without having to meet agreed ESG targets. In particular, investors pointed to the practice of issuing bonds which are callable or redeemable before performance against the sustainability metrics outlined in prospectuses are due to be reported.
The concerns were highlighted in a survey of more than 170 credit investors across Europe into the ESG provisions in high yield bonds and leveraged loans, conducted by the European Leveraged Finance Association (ELFA) and the Loan Market Association.
Half of survey respondents said the cost of calling a bond before key performance indicators (KPIs) are tested should be 50% plus the coupon step-up. Over a third (36%) said the call price should be either 75% or 100% of the coupon.
Greenium refers to the higher price investors are willing to pay for green or other sustainability-related bonds, compared with conventional debt. This largely results from demand outstripping supply but can also reflect a willingness by investors to pay more for greater transparency and certainty over how fundraising proceeds are spent. This is typically outlined in advance and monitored throughout the lifetime of the bond, via a series of targets or KPIs, sometimes linked to financial penalties if these are not met in the form of a coupon step-up.
According to the survey, 51% percent of respondents believe greeniums are justified in green, social or sustainable (GSS) bonds if the structure and targets are robust and credible; nearly 55% believe that a similar premium is justified for sustainability-linked bonds (SLBs). While the former typically refers to instruments which fully ringfence proceeds for the financing of a specific facility or project, the latter indicates that the proceeds will be used in a variety of ways to support the issuer’s transition to a more sustainable business model.
The first US$-denominated SLB was issued by Italian energy generator Enel in September 2019, followed by three €-denominated tranches in October. The latter mature in 2024 and 2027, issued with 0% and 0.375% coupons respectively, offering 25bps step-up triggered by failure to reach sustainable performance targets, in this case a renewable energy installed capacity goal measured in December 2021.
Sabine Fox, CEO of ELFA, said the market for high yield sustainability-related bonds is still in its infancy, but warned issuers to take note of investor concerns. “It is important that any potential concerns among investors are tackled at this early stage to ensure the European leveraged finance market is both resilient and transparent. An issuer’s proposals must be robust and ambitious enough to guarantee the integrity of the product and limit greenwashing risks,” she said.
The survey also found that a third of investors (37%) believe two to five years is an appropriate timeframe for a borrower to test KPIs, with a quarter (25%) saying it should be less than two years, falling well within industry standards for non-call period.
Further, three-quarters of investors said that the market standard 25bps coupon step-up for failing to meet KPIs is insufficient. Two in five (39%) said the coupon step-up should be 25-50bps, while 30% said it should be more than 50bps or equivalent to 20-50% of the final coupon.
Most investors also indicated that external verification of KPI selection and targets should be conducted in advance, but a sizeable minority said they were prepared to forego this process if there are high levels of disclosure on internal expertise and the methodologies used to define KPI targets.
ELFA represents European leveraged finance investors from fixed institutional fixed income managers, including investment advisors, insurance companies, and pension funds.