Enhanced terms can increase appetite for sustainability-linked bonds

That’s not to say that sustainability-linked bonds could not be enhanced. For a start, investors actually benefit from a company’s bad environmental performance through receiving higher coupon payments. In response, some investors have pledged to donate any gains they make to ESG charities.

Instead of leaving it to the environmental conscience of individual investors, directing such funds to ESG causes could become the default option, by hard-wiring charity donations or carbon offset payments into the bond terms.

Loan contracts may provide model for more effective terms

And rather than merely relying on sticks, it may also be possible for bond market participants to adapt some of the terms more commonly seen in sustainability-linked loans to incentivize better ESG behavior, such as interest rate decreases as a reward for good sustainability performance. We are starting to see these features appear in certain bonds, although more widespread adoption will require some market education.

The current market and investor expectations for SLBs are shaped by voluntary guidelines such as the “Sustainability-Linked Bonds Principles” published by the International Capital Markets Association With $189bn in issuance volume in 2021 and year-on-year growth of 941% further market guidance on the donation of gains from poor ESG performance may be desirable.

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