Financing the transition of the highest carbon emitters with sustainability-linked bonds

Published on: 14 October 2022

Sustainability-linked bonds offer resource-intensive industries a viable solution to finance change and work towards a greener future. But there are plenty of challenges. Four of APG’s experts in this field explain how large investors can play a role in this transition. “We believe it is our role is to help push the market in the right direction.”


Sectors like steel, cement, chemicals and some forms of transportation support many of our basic needs. But these hard-to-abate industries are also collectively responsible for nearly a third of global CO2 emissions. As a major responsible debt investor, APG is taking a proactive stance in looking at ways to support this challenging but vital transition and is committed to playing a role in the development of the sustainability-linked bond (SLB) market. Finding instruments to help finance these changes requires APG to tread carefully as a responsible investor.


“Through constant engagement with the market, we believe we can implement our clients’ investment policy and help companies make the transition,” says New York-based Simone Andrews. She works together with fellow fixed income responsible investing expert in Amsterdam, Willem Hettinga, US credit analyst Joshua Linder and EU credit portfolio manager Oscar Jansen. They draw up investment guidelines and liaise with issuers, banks and peers to critically assess new issue structures and ensure the sustainable integrity of this growing market.


Different pathways to transition

Promoting transition in these hard-to-abate sectors is challenging and expensive; each industry requires a different approach and has a different timeframe. “For the automobile industry there are credible avenues using EVs but these are expensive and mineral intensive while large-scale change in the chemicals sector is further away, although there are potential solutions to explore, for example, using hydrogen to drive net zero goals,” explains Andrews. “In determining how to invest, we first evaluate potential bond investments to ensure they meet our financial risk and return requirements, as well as identifying investments that contribute to the SDGs. We also leverage our Guidance on Sustainability-Linked   and have developed a specific but related framework for different industries according to the challenges they face and the transition stage they are in. For example, we have recently documented our guidelines for financing the transition in the aviation industry.”


Flexible SLB structure gives companies more options

There are pros and cons to all types of bond structures. In the past, issuers and investors including APG have generally preferred the use-of-proceeds structure, of which green bonds are the most common flavor, because they have a clear link to projects that create real world impact. But things are changing as the increased flexibility the SLB structure offers becomes more widely acknowledged.


“In the case of green bonds, the money is earmarked for specific projects, so it is easier to determine whether an issue is green enough to fulfil investment requirements and then to monitor how the proceeds are spent and calculate the impact of the investment. But a company has to have sufficient upfront and credibly green spending requirements to make this feasible,” explains Hettinga. “We have seen examples of green bonds issued by energy and mining companies, where the proceeds may have been credible, but the rest of the company’s strategy is not truly focused on transition. Such issues are not always well received by the market, so it is also in the company’s interests to use a structure that fits.”


Most companies in hard-to-abate industries are inherently not so green – the transition time frame is longer, and it is much harder to set aside spending purely for decarbonization. The SLB structure enables these companies to align issuance with their overall corporate sustainability strategy, by setting targets in the form of Key Performance Indicators (KPIs) and Sustainability Performance Targets (SPTs). Hettinga: “For companies that choose this structure, the quality of the goal setting is key. There should be clear communication on the rationale and process for selecting the KPIs, which should, in turn be realistic but still ambitious and clearly linked to the company’s transition path and goals.”


Credible and comprehensive long-term transition plans

Many hard-to-abate industries have a high relative proportion of Scope 3 (or indirect) emissions[1]. These are more difficult to address than direct (Scope 1 and 2) emissions as they often occur beyond a company’s direct control and require it to focus on change throughout its entire value chain. This also strengthens the case for the SLB structure, where a long-term plan can be established with KPIs that can reflect the progress made on transition in all areas of a company’s business. “We turned down an issue that laid out ambitious reduction plans for direct emissions (Scopes 1 and 2) in its KPIs but incorporated no target for the indirect emissions that made up 98% of the total emissions”, explains Jansen. “We prefer to see KPIs that incorporate a broad transition plan with absolute emission reduction targets, clear spending programs and concrete time frames.”


Intensive engagement with issuers and underwriters

“As a major investor, APG has an important role to play by providing feedback to issuers to create a virtuous circle where a landmark deal for a sector can set a positive precedent. We do this by being transparent on what our standards are, by staying in close contact with issuers and determining parameters together with them,” explains Linder. This process may require our responsible investment experts, portfolio managers and credit analysts to go back to the drawing board and dive deeper into the issuers’ business to determine an acceptable level of ambition for KPIs and targets. Jansen: “This approach enables us to fine tune our guidelines for specific sectors and gives the banks that underwrite the bonds and the issuers a pathway to follow, also by making it clear upfront when we will and won’t invest.”


Supporting the SLB market

The annual APG roundtable on the sustainable bond market plays a key role in keeping major players aligned. Now in its fifth year, this event has gained increasing traction and attracts a diverse group of investors, underwriters and other stakeholders who exchange views on ways to promote and develop the labeled bond market. Andrews: “In the 2022 roundtable we focused on the role SLBs can play in financing the energy transition and zoomed in on the aviation sector, this discussion contributed to APG’s guidance on how to approach the challenges and opportunities in this industry”.


Some dedicated green bond investors are not in favor of what they deem to be the looser structure of SLBs and the potential for greenwashing. But other ESG investors are supportive of the market’s development as it opens up opportunities to a broader group of issuers. Linder: “Some of the criticism is valid, but we believe our role is to help push the market in the right direction. It’s more art than science – a balance of wanting to help the market grow, while maintaining its integrity, and accepting that some issuers are further along in the process than others.”

Scope 1 covers all direct emissions from the activities of an organization. Scope 2 are indirect emissions from energy used by an organization to sell its main products or provide its main services. Scope 3 emissions are all other indirect emissions