Structuring formats and thematic proliferation: orientation map

Newsletter

The past months have evidenced two important standards developments hosted by the ICMA: an update of the Social Bond Principles and the establishment of the Sustainability-Linked Bond Principles (see related article). Meanwhile, there is an ongoing consultation on the establishment of an EU Green Bond Standard, which will require  alignment of the Use-of-Proceeds (UoP) from the bond with the EU Taxonomy of Sustainable Activities. These developments, together with the new standard proposed by UNDP to support bond issuers that want to channel finance to meeting the SDGs (also see related article), create a labyrinth of standards and branding that some actors struggle to navigate. However, we believe most of the formats or labels match various specific needs and constraints, there is indeed a need for clarity but not at the expense of innovation that must not be stifled. 

Hence covering  i) most of all existing bond formats and ii) likely capturing the wide varieties of funding needs : either project-related with the ability to track to proceeds) and/or general purpose with the ability to monitor the issuer’s commitments translation into actual sustainability performances.

Table 1 - Type of Bond, labelling, standards and purpose

Source: Natixis GSH

However, the development of new thematic segments such as SDG Bonds and Transition bonds, reshuffles the cards and questions the interaction between framed bond structuring formats and the labeling of thematic bonds that can fit into several formats. Some diverging interpretations by market participants may have caused some confusion.

For instance, several self-labelled Transition Bonds issued recently have sparked some controversy or at least, scrutiny from investors that have well-established requirements regarding green and sustainable bonds. These instruments are criticized for their lack of clarity regarding the environmental guarantees they offer, the articulation between UoPs and the long-term SPT (Sustainability Performance Target) / KPI-linking implementation and, finally, the impact reporting commitments related to the transition induced by the transition approach self-labelled by issuers.

Last year, Marfrig ignited the labelling debate with a Transition Bond dedicated to the supply of cattle respecting Marfrig ́s eligibility environmental and social criteria and ill-defined no deforestation commitments. Marfrig was followed, a few months later by CACIB which issued a UoP Transition Bond as a private placement for AXA. The latter took the side of gas serving a transition strategy, with no specific long-term demonstration as to the compatibility of this resource with a 2°C scenario. Note that Marfrig issued under a “transition” label, had an SPO from VigeoEiris but did not claim any standard (GBP) compliance.

In March, British Cadent Gas Limited, came to market with an inaugural 12-year UoP Transition Bond targeting, among other clear green proceeds (eg. renewable energy) retrofit of gas transmission and distribution networks. A classification that was deemed in line with Green Bond Principles, CBI’s Climate Bonds Taxonomy, and more importantly with EU taxonomy for Sustainable Activities. Similarly, Italian SNAM Rete Gas came to the market in June with a self labelled Transition bond which was claiming GBP compliance, adding to their existing Climate Bond Framework the retrofit of gas transmission networks, which is also in line with the EU Taxonomy (and the EU Green Bond Standard). Both of these issuances, legitimately, raise the question of the recourse of the “transition” label where the existing “green” label applies.

Lastly, in June, HK based Castle Peak Power issued self labelled Transition bond taking the arguable (and argued) stance that LNG terminal and new CCGT units development or Retrofit of gas transmission network can contribute to transition to a lower-carbon future, and therefore using such label outside of any existing standard.

Whilst the contribution of hard-to-abate industries to low carbon economy is somewhat controversial and heavily debated in the finance community, it offers, thanks to such transition themed bonds, the potential for significant mitigation levers. But what should really question the market is the ability of issuers to articulate these bonds with long-term decarbonization trajectories to steer the economy towards a trajectory consistent with the Paris Agreement commitments. To date, no transition bond issued is associated with such clearly established objectives. This would be very much in line with the results of the vast consultation of the Climate Transition Finance working group under ICMA Green Bond Principles governance. Indeed, a clear consensus arose from this consultation: the long-term target of any debt finance for climate transition should be aligned with the goals of Paris Agreement and this target should be supported by disclosure on their decarbonization pathway. What also came as a clear consensus of this consultation is that issuers can link a corporate-level transition strategy to a specific debt issuance by either financing/refinancing CAPEX and/or acquisition of companies that help them align their climate trajectory or by taking a KPI-linked approach to  climate transition finance, i.e. embedded within the structure of the bond (eg. with coupon step up/down), as it is now possible and should be clearly governed under the newly established Sustainability-Linked Bonds Principles mentioned above.

Natixis GSH carries the vision that the transition to a 2°C aligned economy cannot be achieved by ignoring hard to abate carbon intense industries or by subscribing to too short time horizons to offer them the opportunity for a just and orderly transition approach (see dedicated content : here). Such Transition thematic Bonds must be linked to specific and holistic commitments and continuous monitoring mechanisms that confirm issuer’s skin in the game when defining their own transition strategy and come with a clear demonstration of all transition levers being mobilized and their contribution to the company’s transition pathway, being challenged against its ambition (vs peers, sector and science).

Whether under Use of proceeds or Sustainability-linked formats, we believe “transition labelling” is a very relevant example of a new area of development for “common language” allowing for innovation while avoiding dispersion & green / sustainable washing and protecting integrity and actual impact focus.

It does not necessarily mean defining new instruments per say, but it calls for some collective work to define the minimum conditions (disclosures, ambition, conditionality, etc.) under which such labels can and/or should be used, what data-sets, tools and best-practices are available out there, as well as what type of green & sustainable finance instrument / format can be used.  We have expanded here the example of the transition label, the same clarifications would be welcome on other broad band labels such as SDG bonds, Covid bonds or Blue bonds.


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