Sustainability-linked bonds: new opportunities, but avoid greenwashing

Published on: 9 July 2021

APG recently participated in the issue of a number of sustainability-linked bonds (SLBs). Companies issuing such bonds promise to meet predefined sustainability objectives; if they fail to do so, they need to pay investors extra interest. This offers flexibility, but also means investors must pay close attention to the sustainable objectives to prevent greenwashing. “We need to do our homework thoroughly to weigh the credibility and robustness of these deals.”


Tesco is one of the growing number of companies to have issued a ‘sustainability-linked bond’ (SLB) this year. In January, the British supermarket chain launched a bond that is linked to the company’s commitment to reduce greenhouse gas emissions. Concretely, Tesco pledges to cut its greenhouse gas emissions by 60% in 2025 (compared to 2015). If the company fails to meet this objective, investors will receive a coupon premium.    

Rapid growth

APG on behalf of its pension funds participated in Tesco’s €750 million SLB issuance, the first of its kind by a retailer. So far, SLBs remain a small part of the ESG fixed income landscape, relative to conventional labeled (green, social and sustainable) bonds. But SLB issuance is growing fast in 2021. According to Bloomberg, over €12 billion of SLBs has been issued this year to date, nearly 5% of total labeled bond issuance in that period.

So what is a sustainability-linked bond? SLBs allow the issuer to raise money for general purposes while promising that if they fail to meet specified sustainability targets they pay investors extra interest. Such key performance indicators (KPIs) are, for example, ‘percentage of recycled materials used by 2030’ or ‘reduction of greenhouse gas emissions by 2025’. This is different from conventional green bonds, where the money raised has to be spent on specific sustainability projects.

The instrument is still fairly new. In 2019, Enel issued the first SLB. The Italian power utility company targeted a 55% share of renewables in its power generation capacity by the end of 2021. Investors will receive 0.25% extra interest on their bond holdings if Enel fails to meet this commitment. In the run-up to the issue, Enel discussed the particular features of this bond with a select number of investors, including APG.

Prevent green washing

Since mid-2020, the number of SLB issuances has been steadily rising, an encouraging sign of momentum in this nascent market. The flexible structure of SLBs may offer an alternative for companies which – owing to the nature of their business – face difficulty in finding sufficient (or sufficiently large) sustainability projects to issue a green bond. Retail companies, like Tesco, are an example. SLBs allow such companies to finance their overall sustainability strategy without having to ringfence the money for particular green projects, e.g. building a solar power plant.

However, that same flexibility also means that investors have less concrete information on how the proceeds will be used and the potential impact they will have. “Flexibility in terms of use of proceeds combined with customized key performance indicators could make it easier for issuers to ‘sustainability wash’ and twist objectives to suit their needs,” says Joshua Linder, Credit analyst Fixed Income at APG. “For that reason, some investors are hesitant to support this new structure. But we see a lot of potential for SLBs, provided the integrity of the market is firmly maintained. We need to carefully scrutinize the KPIs to find out if they are ambitious and robust enough and ensure they can be properly verified and tracked.”

Tesco’s SLB is aligned to its newly introduced Sustainability Bond Framework which, in turn, follows the International Capital Market Association (ICMA) principles on SLBs, released in June 2020. The ICMA principles aim to further develop the key role that debt markets can play in funding and encouraging companies to contribute to sustainability. The principles pertain to setting KPIs, bond characteristics, reporting and independent verification.

Hybrid bond

Recently, APG also participated in a ‘hybrid’ bond issued by NextEra Energy. This bond, one of the first of its kind, combines features of both conventional green bonds and SLBs. NextEra Energy is a US utility holding company overseeing the largest investor-owned utility in the United States, which serves more than 11 million residents across the state of Florida. NextEra Energy also owns a clean energy business, which is the world's largest generator of wind and solar energy.

The bond structure follows the ICMA green bond principles and ringfences the bond’s proceeds for specific renewable energy projects. However, it is also stipulated that if the company fails to fully allocate the proceeds within two years, investors will receive a 0.25% interest premium until maturity. Also, projects must become operational within twelve months after issuance, or replacement projects must be selected that still meet the two year window, or be subject to the higher coupon rate.

“These features create an added layer of accountability compared to conventional green bonds,” says Craig Hauret, Senior Credit analyst Fixed Income at APG . “It ensures proceeds are allocated to eligible green projects in a timely fashion. Another attractive feature is the requirement that proceeds finance only wind and solar energy projects that will become operational after issuance. As opposed to some green bonds which allocate proceeds to ‘refinance’ projects that were completed two or three years ago.”

This is not to say there aren’t any drawbacks to the deal, notably the absence of a green bond framework which typically serves as the basis for project eligibility, as well as the lack of independent audit. “We have communicated that concern to the company,” says Hauret. “However, we have confidence in NextEra due to its long-time status as an ESG leader, combined with the transparency into the specific renewable energy projects being financed.”  

Upholding market integrity

APG is one of the world’s largest green, social and sustainable bond investors and an advocate of the labeled bond market, including SLBs. “We are, however, very selective in terms of which SLB deals we support in these early stages of market development in order to uphold market integrity,” says Linder. “For instance, we have seen SLB issuance where one of the sustainability targets had already been achieved. Clearly, such a bond does not meet our standards.”

The need for transparency and effective reporting practices is crucial for upholding the integrity and credibility of this rapidly growing market. To make (potential) issuers aware of our expectations and foster healthy development of the market, APG has published the Guidance on Sustainability-Linked Bonds.


APG’s fourth annual ‘Growing the US Corporate Green and Social Bond Market’ roundtable event for institutional investors, capital market underwriters and other stakeholders this year focused on SLBs.  “Growing the corporate labeled market in the US whilst upholding market integrity has been a key objective since we started these events, “ says Anna Pot, Head of Responsible Investments Americas at APG. “We have made substantial progress on activating our peers and partners across the industry to stimulate issuance of high-quality corporate labeled bonds.”