Bond Penalties Loom for Ever-Larger Group of ESG Issuers

(Bloomberg) -- A growing number of firms behind ESG-linked bonds may now be facing financial penalties that would drive up investor returns once triggered.

The development is playing out in the $300 billion market for sustainability-linked bonds, with 19 benchmark issuers having committed to meeting pre-determined performance targets this year. Of those, three will likely miss their targets while a further four issuers only have a 50/50 chance of avoiding penalties, according to an analysis by the Anthropocene Fixed Income Institute. 

Five years after the first ever SLB was issued, a growing number of the securities are now bumping up against potential trigger events as targets spanning emissions reductions to ESG ratings are tested. As a result, “a larger cohort of bonds will reach their observation date” for such targets than was the case in 2023, said Jo Richardson and Patricia Hutchinson, the AFII analysts behind the study. 

The SLB market has already been rocked by one major event this year, after Enel SpA was forced to pay higher coupons on about $11 billion of its bonds after missing targeted emissions reductions. Enel, which blamed the development on the energy crisis that followed Russia’s invasion of Ukraine, issued the world’s first SLB back in 2019. 

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For investors, Enel’s trigger event served as something of a proof-of-concept for SLBs as it demonstrated how a relatively new debt market can hold ESG issuers to account. 

Enel’s penalty was predicted by AFII several months before the company confirmed it had missed its targets. It had to pay a total of roughly €83 million ($90 million) in additional interest, according to estimates by Bloomberg Intelligence. 

Companies that now look on track to pay penalties on their SLBs are A2A, Europcar and London & Quadrant Housing, according to AFII’s analysis. 

A2A, an Italian utilities firm, will likely miss a target to install renewable energy capacity triggering a 25-basis-point coupon increase, AFII said. An A2A spokesperson said an update on its SLB target will be provided to the market at a later date, adding that the company “maintains its commitment” to increasing its renewables portfolio.

Europcar, a vehicle rental firm, had set targets relating to the emissions intensity of its cars and vans, as well as the percentage of its fleet classified as green. At least one of these is likely to be missed due to industrywide challenges facing the sector, according to AFII. Missing either target would result in a 12.5-basis-point coupon step-up on the bond.

Europcar’s targets are ambitious and “beyond the average decarbonization for the rental car sector, which ultimately is driven by customer preference,” Richardson and Hutchinson wrote in their analysis. Representatives for Europcar didn’t immediately provide a comment.

London & Quadrant issued a statement in March flagging it would likely miss one of its SLB goals relating to emissions, triggering a 12.5-basis-point coupon increase. Waqar Ahmed, director of finance at the housing association, said at the time that disruptions to energy markets and the UK’s cost-of-living crisis were largely to blame. 

Investors have been on the lookout for signs that SLB issuers might miss targets given the impact such an event can have on bond prices. Evidence that a significant number of SLB issuers now face the prospect of higher coupons may persuade more investors to consider moving into the debt class and ease concerns about the integrity of the SLB market.

(Updates with details on coupon increases from eighth paragraph.)

©2024 Bloomberg L.P.

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