We live in a world where we cannot pass a single day without hearing about climate change and the need for change around us, and rightfully so this trend has finally caught up with the financial world.
Investors have been particularly interested in acquiring companies with successful environmental strategies to invest in the booming “green bonds” and “sustainability-linked bonds” (SLB) market. Green bonds are use-of-proceeds bonds (UOP). As consumers are demanding more ethical companies, these bonds are revolutionary in enabling corporations to follow and implement environmental guidelines. In fact, the recent UOP and SLB market is around $1 trillion and $250 billion respectively.
These bonds raise debt capital for the issuing company, usually at a lower yield price than traditional bonds making raising capital much cheaper. Furthermore, these bonds help alleviate the issuer's reputation in the general public as they claim to hold green credentials, furthering their financial growth in the long run. But what makes them so unique and how are these bonds utilised? Whilst SLBs and green bonds can be quite similar in the sense that they are linked to environmental goals, some major differences determine how the money is used and who can raise it.
SLBs can be issued by any company that sets out an environmental strategy with some key performance indicators (KPI), that they must meet. If an organisation does not meet its KPIs, there is a step-up price on the bonds that increases the money that it must pay to the debtholders. Furthermore, the money raised can be used for any purpose by the issuers including business expansion, if they wish to.
However, there are major concerns about companies greenwashing their strategies when issuing these bonds as almost any firm can raise them. As mentioned above, there is a step-up price on the bonds that increases its return price. However, the step-ups are often too small to incentivize issuers to clean up their environmentally hazardous practices. Furthermore, the call-up option allows investors to recall back bonds before the step-up, cheating the public by advertising their so-called green credentials.
Some of SLB’s drawbacks can be mitigated by issuing green bonds instead as they can be issued by majorly green companies, who wish to raise capital to further their green projects or assets. Thus, the money raised by green bonds must be used to invest in the company’s future green projects. These bonds act as a major incentive for companies who wish to become more environmentally sustainable but lack the funds to do so with the currently existing debt instruments.
This might seem like the better alternative, however, there are some practical considerations for investors. Firstly, as noted by many analysts, finding organisations that have major green projects or assets that can also provide sizable returns is quite difficult. Furthermore, there is a requirement to disclose any risks associated with the environmental practices, such as any transitory risks such as government policy changes or any harmful emissions from your sustainable practices. Conducting such extensive research adds to the cost of acquiring the company or prevents the issuers from raising capital through these bonds.
In navigating the evolving landscape of green and sustainability-linked bonds, investors must weigh the financial benefits against the challenges associated with ensuring genuine environmental commitments. Striking a balance between financial returns and environmental responsibility is crucial for shaping a sustainable and ethical financial future for companies and the general public.
By Priyal Barbariya