When luxury fashion brand Chanel issued €600 million of bonds last September, there was an unusual catch: if the company fails to meet its sustainability goals, it will have to pay penalties to investors.
The deal is an example of a new type of debt known as a sustainability-linked bond, which is a way for businesses to finance themselves while tying repayments to their sustainability targets. That is different from traditional green or sustainability bonds, where the money raised has to be spent on a specific green or social project.
“Sustainability-linked bonds essentially help companies create an ambitious and accountable pathway to support their overall sustainability strategy,” says Delphine Queniart, global head of sustainable finance and solutions at BNP Paribas Global Markets.
Chanel’s bond sale consisted of two separate deals for €300 million each. The first commits the company to cutting its greenhouse-gas emissions in half by 2030 and reducing emissions in its supply chain by 10 per cent. The second pledges to transition to 100 per cent renewable electricity across the company’s operations by 2025.
If Chanel fails to meet its emissions targets, it will have to pay a cash penalty of 0.75 per cent, almost doubling the 1 per cent interest rate it is paying to borrow the money. Likewise, if it fails to meet its renewable electricity target, it will have to pay an additional 0.5 per cent premium on top of the 0.5 per cent interest rate for that bond.
In addition to emissions targets and renewable energy goals, some issuers have included targets related to diversity. Schneider Electric’s deal in November 2020, for instance, included a target to improve gender diversity across its business so that by 2025 women will account for half of all new hires, 40 per cent of front-line managers and 30 per cent of its leadership teams. It has also committed to training one million underprivileged people in energy management by 2025.
“A few years ago it wasn’t that easy to hold companies to account and track their ESG [environmental, social and governance] improvements, but sustainability-linked bonds will help you to do that,” says Mark Munro, fund manager at Standard Life Investments. “These will help move the conversation forward; it’s much better to think about a holistic ESG target for a company rather than just a specific project.”
Italian energy company Enel issued the first sustainability-linked bond in 2019, taking a cue from the loan market where interest rates could be ratcheted up or down depending on whether or not certain metrics had been met. That remained the only deal until last year, when the introduction of the International Capital Market Association’s Sustainability-Linked Bond Principles, which provide guidelines around how the bonds should be structured, spurred more companies to follow suit.
Chanel, Novartis and Suzano! all issued bonds in September 2020, with more deals following in November after the European Central Bank said it would accept sustainability-linked bonds as collateral.
In total, companies issued roughly $9 billion of sustainability-linked bonds in 2020, according to Ángel Tejada, head of the green bonds group at Spanish bank BBVA. He believes there could be anywhere up to double that amount issued over the coming year.
“We will likely see issuers trying to complement their green bonds with sustainability-linked bonds because they offer more flexibility and less limitations on what they can spend the proceeds on. But we are also likely to see new issuers that aren’t able to fund sufficient…