(Bloomberg) -- In one of the hottest corners of ESG debt, issuers have started altering documents so they can change their targets without getting bondholders’ permission.

It’s a variation on the sustainability-linked bond, which generally requires an issuer to meet pre-determined environmental, social or governance goals within a given timeframe, or face higher borrowing costs. The more flexible version of the SLB allows issuers to adjust those targets under certain conditions, without incurring a penalty.

“The current wording of these fallbacks gives a relatively high degree of discretion to the borrower,” said Arthur Krebbers, head of corporate climate and ESG capital markets at NatWest Markets Plc. 

For now, such flexible SLBs make up a tiny fraction of the wider ESG debt market, which Bloomberg Intelligence estimates will mushroom to $15 trillion by 2025. But bankers watching the development say the new, more flexible product is likely to catch on, as issuers look for ways to cope with increasingly volatile markets in which key ESG parameters such as energy prices become harder to predict. 

“Capital markets need to be able to find solutions for unforeseeable events,” said Paola Leocani, a partner in the debt capital markets group at law firm Simmons & Simmons. 

Investors, meanwhile, may not always be aware of the new clauses in their prospectuses.

“It is likely that issuers will be expected to provide greater clarity on the flexibility they desire,” Krebbers said in an interview. “It’s very natural that investors will start scrutinizing these provisions more closely, especially if we see cases of borrowers unilaterally changing sustainability goals without clear context.”

The ESG debt market, like most others, has this year been buffeted by decades-high inflation and the sudden return of rising interest rates. That’s led investors to be more discerning, with greenwashing an ever-present concern. Researchers at the Federal Reserve have noted that SLBs could be more effective than green bonds at connecting investors with firms making systemic green investments.

But SLBs have also attracted criticism. Even before issuers started introducing flexible terms, weak targets and tiny penalties left some creditors cautious. A number of the world’s largest ESG bond investors refuse to touch SLBs, while early investors have voiced concerns that corners of the market risk losing credibility. So-called “sleeping” sustainability-linked loans, where borrowers don’t need to specify their ESG targets from the get-go, are also sparking concern. 

For an investor, a sustainability-linked bond’s price depends in large part on the risk that the issuer might miss its ESG targets. So changing the terms complicates the valuation process. 

Any issuer contemplating such adjustments should be required to get investors’ permission first, said Rhys Petheram, a fund manager at Jupiter Asset Management. 

“It makes it a lot more difficult for me to have confidence whether an instrument will actually deliver what we want to do in terms of impact, if the conditions can change in the future without any bondholder consent process,” he said.

Marketing documents for flexible SLBs highlight such risks. The prospectus of an SLB sold by Accor SA lets it recalculate its ESG targets under various circumstances if, in the opinion of the issuer, such changes have no adverse impact on the interests of bondholders and an external verifier approves the change. It also offers a few caveats.

“Any of these changes to the standards, guidelines or in the calculation methodology may not be in line with investors’ expectations,” the prospectus notes. “Such changes may have a negative effect on the market value of the bonds.”

Other borrowers using flexible SLB terms include Aeroporti di Roma SpA, which added a clause to allow for “emissions redetermination.” Such an event may be triggered by changes to Italian regulations affecting airports, according to the amended terms and conditions of its debt issuance program. 

Enel SpA added a flexibility clause to allow for the emergence of better ESG data, as well as the potential impact from any future merger or acquisition. Siemens AG tweaked its SLB terms to allow for a variety of circumstances, including the risk that it may no longer be free to use carbon-offset credits to calculate its net emissions.

“We believe the possibility to update the targets should be restricted to scenarios of major changes where the new targets are at least as ambitious as the original ones,” an Enel spokesperson said. Incorporating flexibility in SLBs “is important as companies’ business, ESG data quality and ESG strategies evolve continuously.”

An Accor spokesperson referred to earlier statements regarding the flexible terms of its SLB. A Siemens spokesperson declined to comment. Aeroporti di Roma didn’t respond to a request for comment. 

SLBs with fallback clauses generally commit the issuer to act in good faith and to make appropriate disclosures to bondholders. The International Capital Market Association, an industry group which produces voluntary guidelines for the ESG-labeled debt market, is urging issuers to explicitly communicate if their targets have any flexibility. 

For flexible SLBs to gain investors’ trust, Leocani at Simmons & Simmons underlined the need for third-party involvement.

“External verifiers should confirm new key-performance indicators are in line with the materiality assessment made at issuance,” she said.

(Adds detail on “sleeping” sustainability-linked loans in ninth paragraph.)

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