This year is set to be a bumper one for missed targets in the sustainability-linked bond (SLB) market, according to experts, who say it will give investors a ‘status check on the transition’.
It was revealed this week that Switzerland’s largest power producer, Axpo Holdings, had missed its renewable energy goals by 34%. And in a recent document, French hospitality company Accor, another SLB issuer, suggested that it was on track to miss its climate targets by the end of the year.
SLBs have their coupon tied to specific sustainability goals. This means that the issuer must – depending on the structure of the deal – pay either a higher coupon for missing its targets, or a lower one if it meets them.
The first issuers to miss targets, back in 2022 and 2023, were electricity providers, but since last year the types of companies and their locations have widened to include vehicle rental firms, housing associations and manufacturers.
“These bonds are now coming from a really broad range of sectors and jurisdictions,” explained Jo Richardson, the head of research at Anthropocene Fixed Income Institute.
“And, crucially, they commit the issuer to reporting on progress,” she said, adding: “Without that accountancy mechanism, some of these companies might not be telling investors how it’s going at the moment.”
Richardson predicts that 2025 will be a “big year” for missed SLB targets, because 2025 is a common deadline in sustainability strategies.
“SLBs will provide a real opportunity for a status check on the transition this year,” she told IPE.
“Some issuers will be on track, some will be off track. But it’s important, as a market, that we identify where the challenges are, so we can strategise and potentially readjust capital allocations.”
Axpo Holdings, for example, blamed its performance on a number of external factors, including slow approval processes for renewable energy projects, and geopolitical instability.
The company has not disclosed the cost of its step-up, but estimates put it at around CHF3.84m (€4.1m).
Perverse incentives and mispricing?
Many responsible investors have shied away from buying SLBs because they do not want to benefit financially from a company failing to fulfil its sustainability commitments.
But others argue that companies that don’t achieve their sustainability goals may face divestment or policy-related risks, which justify a higher coupon.
“It’s just a hedge that SLBs offer to investors,” said Richardson.
Anthropocene has produced evidence that some SLBs may currently be underpriced.
Between issuance and the target deadline, investors can only speculate about whether the bond will pay the step-up version of the coupon. Then the issuer confirms whether it has met or missed the target.
“At that point, if it says it will miss its target, the probability of it paying a step-up immediately rises to 100%,” said Richardson. “So you would expect the bond to reprice to the level where the bondholder is guaranteed to receive a step-up in coupon.”
But, for fixed income investors who use Bloomberg as their primary source, there will be a lapse between that 100% certainty and the system being updated.
“That’s the third phase, which often triggers investors to realise something has happened, and that can prompt another repricing,” Richardson said, adding that this three-step process creates “inefficiencies in the pricing” of SLBs.
“There may well be opportunities for investors who find them,” she told IPE.
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