In this article series, we are covering why greenwashing has become a problem for asset managers and the expected implications for issuers. Our second article discussed how issuers can directly address the opaque nature of ESG ratings, a potential driver of greenwashing. The article explained that corporate issuers should be clear on the sustainability topics that are material to the business, and that they should proactively engage with ESG rating agencies and other stakeholders on how the company is addressing sustainability related risks and opportunities today and in the future.
In this article, we will expand on those points, as they remain relevant when corporates issue Green, Social, Sustainable or Sustainability-linked (GSSS) bonds. In particular, we’ll focus on how issuers can ensure that their specific sustainably labelled bonds and related disclosures provide relevant information for investors to feel comfortable including them in their portfolios.
Historically, simply issuing a labelled GSSS debt product may have been sufficient for investors. However, our recent investor survey (Figure 1) found an increasing number of asset managers focus on an issuer’s sustainability strategy, and not solely on the type of sustainability debt being issued, as a way for the issuer to demonstrate its commitment to sustainability. Even when reviewing Sustainability Finance Frameworks, the issuer strategy is one of the top two factors that investors are most interested in. As supply of these types of issuances begins to meet the level of demand from investors, further scrutiny on these issuances and the corporate issuers’ sustainability disclosures will follow for investors to ensure they invest in issuances and issuers where they have confidence regarding their sustainability approach.
Figure 1: Which two factors are most important when assessing the robustness of Sustainability Finance Frameworks?
Going beyond the minimum requirements
Regardless of the type of sustainable debt structure used, the issuer is expected to have a framework that explains their sustainability financing approach, and how it links to the corporate’s overall strategy and sustainability objectives.
Whilst there is no legal requirement around these disclosures, there are plenty of voluntary guidelines for these frameworks and disclosures to align to. These guidelines, such as the ICMA Green Bond Principles or Sustainability-linked Bond Principles, explain the basic considerations that issuers should consider when selecting projects or KPIs, and the level of transparency that they should provide. For example, with a green bond, if proceeds can be used for re-financing, or the asset value approach is applied, then it is important that the issuer provides rationale on why re-financing is appropriate, and how the overall projects and eventual impact metrics feed into the sustainability strategy.
There is value for issuers to be transparent in pre-issuance disclosure on the ESG nature of the bond by covering details such as expected project split by types of project, geography or even expected impact. For green bonds in particular, investors may focus on what we coined, in a previous article, as the 4 As:
- Ambition: Is this business as usual, or is an issuer seeking to be industry leading in embracing the carbon transition?
- Alignment with the issuer's overall strategy: Is it a "side show" project, or truly congruent with a company's overall operations?
- Additiveness of the projects: What portion of proceeds will go towards new initiatives?
- Analysis offered on projects: What is the expected, measurable environmental impact?
With a sustainability-linked bond, to ensure that investors feel comfortable with the KPIs and targets, details on the selection of KPIs and the linkage to the issuer’s sustainability strategy should be clearly communicated along with sufficient information on why the targets go beyond what the company would achieve through “business-as-usual.”
It has become market convention to obtain a “second-party opinion” (SPO) for Sustainability Finance Frameworks and their alignment to the relevant principles, such as the ICMA principles. However, as identified in our survey (Figure 2), only 7% of global investors considered the SPO to be among the top two most important factors when evaluating the robustness of Sustainability Finance Frameworks.
This may be because investors expect a positive opinion; therefore appointing an unknown provider or having a highly critical opinion can be unhelpful for issuers and cause undue focus on the negative aspects of the opinion. We expect it will become ever-more important for the disclosures on the issuances – and indeed the issuer – to clearly link the bonds’ KPIs or projects to the overall sustainability strategy. This also includes the post-issuance reporting: all GSSS bonds require regular reporting, which is a good opportunity for issuers to show that the targets or projects outlined in their Frameworks have been met or implemented (or are on track to be), and that those projects or KPIs are still relevant to the sustainability objectives. Beyond simply showing progress against KPIs or that funds have been allocated appropriately, it’s equally important to show investors that these financing instruments continue to help deliver the company’s overall sustainability strategy.
Figure 2: Which two actions best underscore an issuer’s commitment to sustainability?
Exceeding stakeholder expectations
As GSSS bonds become more mainstream, these issuances will need to hold up to reviews, not just from investors, but from other stakeholders as well. Issuers can consider how to proactively respond to challenges from these stakeholder groups in their disclosures. This could range from explaining why certain KPIs are not included as part of an SLB to outlining that an issuer’s overall operations aren’t “brown” even though specific proceeds are allocated to certain green projects.
Corporates can also include their overall ESG credentials as part of their investor marketing. This goes beyond what would be included in a Green or Sustainability-linked framework, and the type and amount of data, level of granularity and topics would vary significantly depending on the company. However, where possible, the ESG information included should link to the company’s financial performance or business objectives. This approach could even be leveraged for a non-labelled transaction or where there may be a view that the issuer is “intrinsically” green. Regardless of the nature of a transaction, incorporating a clear link between the financing and the overall sustainability strategy will likely become an expectation from investors.
From our experience, supporting issuers in going to market with these types of bonds, we know that investors will ask those specific questions about the link between the financing and wider strategy. For example, investors will want to know “How is the bond supporting the sustainability strategy?” and “How does this financing fit into your overall sustainability strategy, as well as your broader business strategy?”
Issuers should also prepare to be asked questions that will not be solely focused on the framework, projects or KPIs. Other frequently asked questions include: “What are the specific metrics that investors can look at to assess your ESG performance?” or “How is the sustainability function embedded in the company’s organisation?” Along these general questions, issuers should also expect to be queried on material ESG topics for their business even if the project categories or KPIs aren’t directly focused on those areas. For example, even for a consumer retail business sustainability-linked bond (SLB) with environmental KPIs, investors may want to know about how the company manages human rights risks in the supply chain or how a real estate investment trust (REIT) manages health and safety - even if its green bond’s projects are focused on energy efficiency.
Additionally, investors are starting to reference green bond indices, so issuers should be aware of those methodologies and if their bond may or may not be included – and be able to address those considerations in engagement with investors.
Considerations for issuers
In all, these activities potentially require more company resources in order to successfully engage with stakeholders, and to ensure that there is substantial data, both quantitative and qualitative, to stand the test of scrutiny. This work will go beyond the Framework and will ensure it aligns to the relevant principles and receives the preferred opinion. Despite these additional resource requirements, the benefits are clear for issuers: to position their bond as part of their overall sustainability strategy and to help investors better understand how the projects (for use of proceeds bonds) or KPIs (for Sustainability-linked) fit in. We envisage that issuers that do this best will continue to reap the benefits from the issuance of labelled bonds.