As the green and sustainability-linked bond market continues to expand, investors are increasingly scrutinizing the potential of their fixed-income holdings to drive meaningful climate impact. However, the lack of an internationally recognized standard has sparked concerns about greenwashing, prompting regulatory bodies to take action. In this dynamic landscape, industry experts explore the merits of different bond structures and the importance of transparency in supporting net-zero ambitions.

Empowering Accountability: The Rise of Sustainability-Linked Bonds

Redefining Responsibility: The Allure of Sustainability-Linked Bonds

Sustainability-linked bonds (SLBs) have emerged as a compelling alternative to traditional green bonds, offering a unique approach to driving climate action. Unlike green bonds, which earmark funds for specific green projects, SLBs tie the bond's terms to the issuer's achievement of predetermined sustainability-related key performance indicators (KPIs). This structure, as explained by Josephine Richardson, former credit trader at JP Morgan Chase and now head of research at the Anthropocene Fixed Income Institute (AFII), "offers greater accountability, though not necessarily a direct tie to asset use."The enhanced accountability mechanisms of SLBs are particularly appealing to investors seeking tangible evidence of an issuer's commitment to sustainability. As Richardson emphasizes, "If the issuer fails to meet targets, it impacts their capital costs. This accountability could be impactful in terms of supporting behaviour change." The example of London & Quadrant Housing Trust, which recently incurred a $400 million penalty for missing an emissions reduction target for its SLB, underscores the potential for SLBs to hold issuers accountable.

Navigating the Nuances: Balancing Green Bonds and Sustainability-Linked Bonds

While the appeal of SLBs is undeniable, green bonds continue to play a crucial role in decarbonization strategies, particularly in high-emitting sectors. As Chandra Gopinathan, chair of the bondholder stewardship group at the Institutional Investor Group on Climate Change, explains, "In high-emitting sectors, green bonds are crucial as they allocate capital directly towards green commitments." However, he emphasizes the need to consider the issuer's overall climate stance, rather than viewing the green bond in isolation.Véronique Chapplow, an investment specialist at T. Rowe Price, a major provider of green bonds, acknowledges the increasing scrutiny of labelled bonds and the importance of rigorous due diligence. "Greenwashing is a significant risk, so rigorous scrutiny of these bonds, and especially issuer credibility, is essential," she states. Chapplow also highlights the potential of a broader approach, noting that one of T. Rowe Price's impact strategies allocates approximately 40% of its portfolio to non-labelled bonds, seeking companies that actively contribute to addressing pressing sustainability challenges.

Accountability Beyond Labels: Integrating Transition Commitments

Ultimately, the panellists agree that a comprehensive view of an issuer's transition strategy and greater transparency are essential to address greenwashing in fixed income. As Gopinathan emphasizes, "Investors should avoid over-reliance on labels and ensure they understand the issuer holistically." He cites the Avengoa case as a prime example, where the green label misled investors who overlooked fundamental governance issues.Gopinathan further suggests that accountability mechanisms can be integrated into labelled debt, stating, "Investors should avoid over-reliance on labels and ensure they understand the issuer holistically." He emphasizes the importance of assessing both labelled and non-labelled bonds based on the issuer's transition commitment, as "sometimes non-labelled bonds offer better risk-adjusted returns with strong issuer commitment."

Navigating the Evolving Landscape: Towards a Holistic Approach

As the debate around the merits of different bond structures continues, the panellists stress the need for a holistic approach that goes beyond labels and focuses on the issuer's overall transition strategy and commitment. Chapplow's perspective on T. Rowe Price's impact strategy, which allocates a significant portion to non-labelled bonds, underscores the importance of looking beyond the label and evaluating the issuer's broader sustainability efforts.Gopinathan's concluding remarks encapsulate the essence of this holistic approach: "We should not get overly focused on format or label alone. It's vital to evaluate each issuer, their financing strategy, and their holistic impact. Labelled bonds are helpful, but they can't replace deep issuer-level analysis." As the sustainable bond market continues to evolve, this emphasis on transparency, accountability, and a comprehensive understanding of issuers' transition commitments will be crucial in driving meaningful climate impact.