Sustainability-Linked Bond Step-Ups Need Refinement: Sustainable Fitch

September 22, 2022: The sustainability-linked bond (SLB) market has continued to grow, attracting a wider range of issuers across sectors, but the pricing model of the debt instrument may require further calibration, says Sustainable Fitch in its latest report.

As per the report, cumulative SLB issuance has increased exponentially, reaching USD147 billion by June 2022. This accounted for 10% of the total sustainable bond market in 1H22, compared to 1% at the end of 2020. While the energy and utilities sector has issued the largest amount of sustainability-linked debt in US dollar value, there is growing diversity among the sectors represented, including food and beverage and pharmaceuticals.

The wider range of issuers and key performance targets set for SLBs supports portfolio diversification for investors and also increases the availability of issuer-level sustainability data.

Since the first SLB issuance in 2019, the market has seemingly coalesced around a fixed coupon step-up of around 25bp, which is triggered when an issuer fails to meet its predetermined sustainability targets.

Sustainable Fitch’s analysis of the market found no correlation between coupon step-up levels and an issuer’s credit rating or the bond’s overall coupon. Further differentiation of step-up rates to account for variations in the financial, operational and sustainability profiles of issuers would improve transparency for investors.

Unlike traditional use-of-proceeds bonds, SLBs grant issuers more freedom in how the funds raised are deployed. This means it can be difficult for investors to ascertain how proceeds are used and what specific sustainability objectives are achieved. More clarity in the materiality of key performance indicators will boost investor confidence that issuer targets are meaningful for their core business activities.

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