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Wealth Management

The mountain and the mouse

Green bonds remain investors' favourite format, with USD 380 billion of new issues (+19%). But what about sustainability-linked bonds (SLBs), and what are the main differences between the two? Catherine Reichlin, Senior Bond Analyst, tells us more.

Interest in the sustainable debt market remains strong. In the first half of the year, $717 billion was issued in various formats, 14% more than in the first half of 2022. Green bonds remain investors' favorite format, with $380 billion of new issues (+19%). Their social and sustainable sisters are also growing, up 18% and 7% respectively. Their cousins, sustainability-linked bonds (SLBs), on the other hand, are lagging behind, down 26%! The two formats may belong to the same family, but there are fundamental differences between them. The former are linked to projects, so investors know exactly what their money is being used for. The latter are linked to the issuer's general objectives, so investors do not know specifically how their money is being used. Enel, an Italian electricity producer, broke new ground in 2019 with this new format: targets set in relation to the company's impact, typically a reduction in carbon footprint, and a penalty for failing to meet those targets. Since then, a plethora of issuers have followed suit, and although SLBs have been the subject of much discussion, they only account for 4% of the sustainable debt market.

Heralded as THE INSTRUMENT of the energy transition, they are provoking more doubts than enthusiasm among analysts. According to an ABN survey, although more fund managers are using this type of bond, 16% still do not allow themselves to buy them. This compares with 21% in 2022. Understandably, the criticisms are still the same: a lack of standardisation that makes it impossible to compare or assess the ambition of the objectives, and a level of penalty for failure to achieve the objectives that lacks materiality. Added to this are sometimes poor market practices, such as early repayment clauses for the issuer just before the penalty is paid, the absence of a second opinion on the structure or the lack of science based verification of the measurements. Very recent issues include London Heathrow Airport, Rome Airport and the car manufacturer Hyundai. These names perfectly illustrate the purpose of SLBs: to support sectors in transition. Let's take a moment to look at the Heathrow issue, whose structure took almost two years to prepare and introduced a number of innovations. To begin with, the issuer distinguishes its emissions "in the air" (95%) from its emissions "on land" (5%) and sets itself targets up to Scope 3 (indirect emissions) - a first for an airport.

Ambitious targets that leave one wondering, especially as the airport is considering building a third runway! The sustainable debt market, all structures combined, now stands at $6.8 trillion. An impressive figure, yet it represents only 2.18% of the debt market. Put another way, SLBs account for 0.09% of the debt market, a marginal fringe that is making, and will continue to make, a lot of noise.

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