Proponents of sustainability-linked debt can’t have it both ways

There is a lot of grumbling in the capital markets about how long it takes to regulate ESG, but the market has shown that it is unable to create the kind of self-government that would make these rules unnecessary.

This week Global Forum of Borrowers and Bond Investors in London, numerous panelists from industry organizations, banks and Think Thanks organizations stated that the labor-intensive way of implementing regulations in the field of environmental, social finance and management hampers the functioning of the market.

They are right. Even though the European Union has been introducing regulations at a rapid pace since introducing the Sustainable Activities Taxonomy in July 2020, there are still major inconsistencies in the rules, which in some cases means that compliance with one principle may prevent a borrower from satisfying another.

This is, at best, a suboptimal outcome for a well-functioning market – something that regulation aims to achieve.

However, the market is not willing and unable to moderate itself properly to make official regulations unnecessary.

When it comes to the use of revenue bonds, the market has largely maintained standards very well, guided by guidance from bodies such as the International Capital Markets Association.

But these bonds are simple. Either the money will go to an ecological project or it won’t. It is the market that decides what constitutes an ecological project for which it has a taxonomy.

For more nuanced designs, the market has shown that it is willing to bend definitions to the point where they become almost meaningless. In the case of sustainability-linked bonds, investors have long complained that KPIs are not ambitious enough, and yet the only tangible impact on SLBs on the primary market is that they do not offer greenium to the issuer.

Of the billions of euros sold to SLB, only a few companies ever had to pay a coupon increase for missing targets. The SLB poster company, Enel, did this brilliantly – it could probably have avoided paying because it wasn’t the company’s fault for not meeting its targets. However, its payment of additional vouchers of €25 million a year shows how unambitious other companies have been.

The goal of the SLB is not for some clever banker or treasurer to shave a few basis points off new bonds, but to slow the rate of climate change.

Over-regulation is bad, but the market has squandered its opportunity to show that it is not necessary.