Step-downs: a step too far?

20 July 2021

Dr Arthur KrebbersHead of Sustainable Finance, Corporates

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Pietro StimamiglioCorporate Financing & Risk Solutions, Sustainable Finance

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Recently, seafood company Thai Union became one of the first companies to issue a Sustainably-Linked Bond (SLB) with a coupon step-down element. Will we see more of such features?

There are reasons to be sceptical: promoting such step-downs to investors is similar to involving the proverbial turkey in planning Christmas dinner – particularly, while credit spreads in most asset classes remain near record lows. Furthermore, there are ongoing concerns that many of the targets set for sustainability-linked bonds are not that stretching, giving rise to the concern of a “freebie”. In the first year of the SLB market, we’ve therefore not seen such structures in any meaningful way (see charts below).

However, equally there are reasons to expect more “symmetric” structures to appear in pockets of the market:

  • The chance to achieve a lower coupon (a step-down) could incentivise a borrower to set somewhat more aggressive targets. This dynamic has certainly been a driver in some of the sustainability-linked structures in the private market.
  • Such structures could facilitate a greater degree of alignment between a borrower’s financings – in particular, between its revolving credit facility (typically includes step-up and down) and its bond issuance. It could therefore more readily pave the way for instrument-agnostic frameworks (as we are seeing in the ‘use of proceeds’ market), that would offer more transparency to all stakeholders.
  • There is a group of impact investors who don’t feel comfortable with being seen to “profit” from a company failing its ESG target. These investors could be early movers in supporting step-down structures.
  • For certain asset classes, such as for example the corporate hybrid market, a step-up is not structurally possible.

For these reasons, we are starting to see issuers consider step-down language within their frameworks and bond programmes. It remains to be seen, however, who will take the first step in the European or US market.

Chart on economics

(Note: Analysis based on Sustainability-Linked Bonds issued in USD, EUR, GBP since 2019)

Sustainability-Linked Bond coupon structure

Source: NatWest, Bloomberg

Total cost in bps if target is not met

Source: NatWest, Bloomberg

ESG


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