28 September, 2021 / Comment
A guide to ESG debt products
By Victoria Judd, special counsel, energy finance team, Pillsbury
Pillsbury's Victoria Judd gives the lowdown on the various green debt products investors can consider for portfolios
When investing in debt products, whether directly or indirectly, there are two main types of products: “green” products and “sustainability-linked” products.
In relation to “green” debt products, the main type is the “green bond”. Green bonds are fixed income products, where the proceeds of the bond offering are used solely to fund a project or series of projects which are good for the environment. This might include projects linked to renewable energy, energy efficiency, or pollution prevention for instance.
On the other hand, a “sustainability-linked” debt product is structured such that proceeds can be used for general corporate purposes, but the company must report on its compliance with several key ESG performance indicators with a view to meeting an ambitiously set performance target. Performance is usually measured on an annual basis and targets are set by reference to the relevant corporate, so are bespoke. CO2 emissions or maintaining/improving an ESG rating are reasonably common metrics that are seen in the market, but a company could also have a metric linked to its use of plastics or the number of women or minorities appointed to the board. A borrower that meets its target(s) will benefit from a lower interest rate. Paying less money for corporate lending is certainly an incentive to achieve the designated target.
In practice, the “green” and “sustainability-linked” characteristics can be applied to different finance products. You can have a green loan or a green bond, or a sustainability-linked loan (SLL) or a sustainability-linked bond (SLB). You can also have blue bonds, social bonds or ESG bonds. The names are broadly self-explanatory, but as always, the underlying documentation will provide the full information about the product, and the ESG product should not be judged by the name given to it on the front page.
Borrowers of ESG labelled debt are kept to account by having to make certain disclosure requirements, and by increased interest payments where they fail to comply.
Of course, publicity and marketing also tend to be a carrot and a stick with reference to these ESG financial products. Companies who fail to comply with their targets or do not disclose relevant information will suffer negative publicity, and if their targets are not sufficiently ambitious, they may even be accused of “greenwashing”, i.e. being misleading about green credentials.
ESG debt products may be less fashionable, but they are certainly more sustainable in the long-term.
While corporate loans tend to be the remit of large banks or institutions, retail investors can still have access to corporates who have borrowed money in the form of an SLL or green loan. Such companies can be favoured through choice of equity investments for instance. The ESG performance of a company will not be determined by the debt it borrows, but as green or sustainability-linked provisions in loans are not yet market standard, inclusion of such provisions remains an indication of a company which has an ESG strategy and is looking to apply ESG principles more generally.
Retail investors with a preference for fixed income can also choose which projects to sponsor through their bond investments, and more recently can buy sovereign bonds or “green gilts”. The UK has issued its first sovereign bond in 2021, with the intention of giving savers the opportunity to take part in the collective effort to tackle climate change, but France and Germany have already made large issuances.
While there is much overlap and similarity between the various ESG financial products, these products are far easier to differentiate than some might at first think. ESG debt products may be less fashionable, but they are certainly more sustainable in the long-term.
A part of the Mark Allen Group.