Key FocusSustainability-

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Socially responsible investing, green bonds and, more generally, sustainable finance occupy an increasingly urgent and prominent role within global capital markets. This Key Focus collects some of GlobalCapital’s most incisive sustainability-linked finance coverage including the EBA’s attempt to put the brakes on sustainability-linked bonds, the LatAm ESG rush, sustainability’s bright future in FIG and the call for transparency on corporate sustainability-linked loans.

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Contents:1. SLB fever sweeps FIG market after Berlin Hyp debut . . . . . . . . . . . . . . . . 4

2. Learning by doing: SLBs to surge, though role still needs defining. . . . . . . . . 9

3. EBA attempts to put brakes on FIG SLBs . . . . . . . . . . . . . . . . . . . . . . 14

4. Corporates must be more transparent on sustainability-linked loans . . . . . . 17

5. EQT mixes CO2 and diversity in first SLB from private equity . . . . . . . . . . 19

6. Uruguay mandates for pesos, dollars as SLB plans evolve . . . . . . . . . . . . 22

7. Berlin Hyp draws blueprint for bank SLBs . . . . . . . . . . . . . . . . . . . . . . 25

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Berlin Hyp burst on to the SLB scene on Tuesday, when it issued a €500m 10 year preferred senior bond at 35bp over mid-swaps.

It had taken roughly nine months to bring the deal to life, as the German bank laboured with consultant Drees & Sommer on the arduous task of producing electricity and heating data for the whole of its loan book.

SLB fever sweeps FIG market after Berlin Hyp debut

Banks are optimistic that sustainability-linked bonds have a bright

future as part of their funding toolkits, after Berlin Hyp became the first

financial institution to land a deal in the format this week. More trades

are already on the way and market participants are stepping up their

efforts to break down the remaining barriers for FIG borrowers.

Sustainability-linked bonds are a

great tool to underline the ESG

trajectory of a company and we

think they could be used by many

other financial institutions.

~ Tanguy Claquin

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The work meant that Berlin Hyp was able to make a clear and ambitious pledge to reduce the carbon intensity of all of its lending stock by 40% over the next decade.

If the issuer fails to reach this target, it will pay an extra 25bp on the final coupon of its 10 year SLB.

“Sustainability-linked bonds are a great tool to underline the ESG trajectory of a company and we think they could be used by many other financial institutions,” said Tanguy Claquin, head of sustainable banking at Crédit Agricole CIB.

“The key challenge was to find the right [key performance indicator] and the right way to structure the target. I think we’ve found that with the Berlin Hyp transaction.”

Crédit Agricole CIB was the sole structuring advisor for Berlin Hyp on its new bond. It was also a joint lead manager, alongside Commerzbank, DZ Bank, HSBC and LBBW.

There was a lot of excitement in the market when the issuer unveiled its new deal framework last Friday.

One analyst described SLBs as a sort of “mini revolution” in ESG debt markets, which have been dominated by deals in the more traditional “use of proceeds” format.

Rather than forcing issuers to commit to sustainability targets, “use of proceeds” bonds require firms to channel their funds towards eligible types of green or socially responsible assets.

“During the marketing process we received a lot of very friendly comments from investors, who were pleased that a bank had finally made up its mind and produced a sustainability-

linked framework,” said Bodo Winkler, head of funding and investor relations at Berlin Hyp. “They thought it was necessary for financial institutions to combine their strategic ESG targets to their refinancings.”

Winkler said he expected the SLB asset class would have a “big future” as part of the FIG market.

“Many of my peers seem very interested in the prospect of doing deals,” he said. “I wouldn’t be surprised if this transaction has set a positive example for other issuers to follow.”

‘Two obvious metrics’Market participants confirmed that there was already a pipeline for more bank SLBs. A head of FIG DCM said he was aware of “at least one other project” in advanced stages, while various other sources said they had been discussing ideas with clients.

Hours after Berlin Hyp came forward with its deal on Tuesday, China Construction Bank also unveiled a new green bond framework in which it gave itself the possibility of issuing SLB deals.

CCB then opened books on three and five year SLBs in dollars on Thursday, through global co-ordinators CCB, Agricultural Bank of China, Citi, HSBC and Mizuho.

Another 13 banks joined as bookrunners: Bank of China, Bank of Communications, BNP Paribas, Bank of America, BOSC International, China Everbright Bank, China International Capital Corp, CLSA, Crédit Agricole, ICBC, JP Morgan, Nanyang Commercial Bank and SMBC Nikko.

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The Chinese issuer took a different approach to Berlin Hyp in terms of its KPIs and sustainability targets.

Instead of focusing on the carbon intensity of its lending stock, it committed to increasing the share of green loans within its overall portfolio.

It must have a balance of green loans equal to 9.5% or more of its total lending by December 2022, in the case of the three year bond, and 10% by December 2023 in the case of the five year. Otherwise, it will face step-ups of 25bp on each of its coupons.

“These are the two most obvious metrics for banks,” said Claquin, referring to the different approaches taken by Berlin Hyp and CCB.

“We may see that it is easier to standardise SLBs in the FIG world, compared with the corporate world, where KPIs are more industry specific.”

Winkler said that Berlin Hyp had also thought about using a KPI based on the green part of its loan book.

The firm has already set itself an objective to ensure green loans make up a third of its overall portfolio by the end of 2025. But it decided against using this as a target for its inaugural SLB.

“It was more relevant and ambitious to use a target based on a reduction in the carbon intensity of our entire loan book,” Winkler said. “The definition of what is green and what is not green is still not quite settled in the wider market, whereas you can clearly measure a reduction in carbon intensity and there can be no doubt about that as a target.”

Room for innovation Market participants were quick to point out that Berlin Hyp seemed an ideal candidate to open the market for sustainability-linked FIG deals.

The German bank has a relatively simple business model, based almost exclusively on corporate real estate lending.

While it would have been a challenge for the firm to produce enough data to estimate the carbon emissions generated by these buildings, the task would be even harder for financial institutions engaged in lots of different types of lending.

“ESG targets may be expected to cover banks’ overall lending portfolios, including Scope 3 emissions,” said a second FIG DCM banker, referring to emissions produced outside of a firm’s own operations. “I’m not sure diversified banks are currently able to calculate and monitor greenhouse gas emissions for such a wide scope.”

Several ESG bankers were hopeful that the arrival of a green EU Taxonomy — due to be published imminently — could help European banks come up with the sort of data needed to embed clear KPIs and targets in sustainability-linked bonds.

But it may take a long time before any official green definitions are widely accepted, which could slow the development of a bank SLB market in Europe.

“We cannot wait until all of the methodologies are final,” said Claquin. “In the meantime, we may see issuers developing their own approaches, as long as they feel they are not taking too large a risk with something that

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could change over time. He added: “The key element is transparency. If the approach is transparent, then investors can make up their minds about the targets.”

In this context, some issuers believe that SLBs will also give them the potential to consider new sorts of ESG objectives, away from their green or social loan books.

Uwe Jurkschat, head of funding and investor relations at Deutsche Kreditbank, told GlobalCapital that his firm hoped it might be able to use sustainability-linked bonds to address themes relating to governance, for example.

“The idea would be to issue ‘use of proceeds’ green bonds to cover ecological targets, ‘use of proceeds’ social bonds to treat social issues and sustainability-linked bonds for topics related to governance,” he said. “This way we would be targeting all of the letters in ESG.”

Deutsche Kreditbank began thinking about how it could issue an SLB at the start of 2021. But it has yet to decide on the sorts of KPIs it wants to use — that conversation will have to take place across different various departments within the institution.

“We will probably need the whole year to prepare a deal, so maybe we could come to the market at some point next year,” Jurkschat said.

Right regulatory recipeA big challenge for many bank borrowers remains the question of whether they will be able to apply sustainability-linked features to all of their different types of issuances.

There is a lot of uncertainty over whether regulators would take a dim view of SLBs intended to count towards capital resources or the minimum requirement for own funds and eligible liabilities (MREL).

Berlin Hyp got around the question this week by removing any language about “bail-in” from its deal documents and making clear that it did not intend for its preferred senior notes to have any value as MREL.

The issuer already has a massive quantity of MREL, which totals 57% of its risk-weighted assets, according to its latest investor presentation.

But other European banks are likely to be more reluctant to give up the regulatory value of their bonds in exchange for issuing in sustainability-linked format.

Claquin said he would not expect any bank to take “a regulatory risk on an SLB”. “We still need to test ideas with investors, regulators and issuers to find out what is the best recipe,” he said.

European MREL rules outlaw step-ups when they coincide with issuer call options, because this is said to create an unwelcome “incentive to redeem” bonds before maturity. The regulations also prohibit debt payments from varying with the “credit standing” of a borrower.

But regulators, including the European Banking Authority, have yet to clarify whether these considerations are relevant when it comes to judging whether standard SLB structures are MREL eligible.

Is a step-up based on ESG targets also an “incentive to redeem”? And do ESG KPIs have

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any bearing on the “credit standing” of a bank? “From what we hear from regulators, there does not seem to be much openness,” said the second FIG DCM banker.

Regulatory uncertainty is likely to push issuers towards taking a similar approach to Berlin Hyp in the near term, or it could force them to consider what they can do in the covered bond market.

Nevertheless, investment bankers are already working on ways to minimise the risk of any potential regulatory confrontation over senior and subordinated SLB issuances.

GlobalCapital understands that one approach being discussed would centre on avoiding the use of a coupon step-up.

Though step-ups are the most common form of punishment in SLB deals, there are other ways of structuring the penalty, such as by varying the amount repayable to investors.

The concept can also be flipped on its head, with issuers being entitled to step-downs if they reach their ESG targets.

“There is no reason why the core building blocks of sustainable finance — incentivising issuers to go further and flagging their investment towards green assets — cannot apply to any financial instrument,” said Claquin. “But it may sometimes take a bit of time to find a good solution.”

The more, the merrier Berlin Hyp secured a very strong outcome for its innovative bond on Tuesday, though market participants were divided over whether the SLB structure helped it to improve the terms of its deal.

The transaction only benefitted from a relatively slim oversubscription ratio, with an order book of €790m to cover a €500m print. This included €133m of demand from the joint lead manager group.

Most bankers attributed the lower levels of appetite to the tight pricing on offer, rather than any problems relating to the format of the SLB.

“We were very happy and very relieved with the outcome of the bond,” said Winkler. “At 35bp over mid-swaps, the pricing was the tightest we’ve seen for a 10 year preferred senior deal for a couple of years.

He added: “We did a lot of investor calls the day before and there was a huge overlap between who we spoke to and who showed up in the book. That was a great sign for us.”

The German lender did, however, encounter the sorts of difficulties that always come with being at the cutting edge of a new market.

Some investors, for example, were said to have expressed regret at being unable to buy the notes because they fell into the category of a “structured product”, which conflicted with their mandates.

But bankers said it would be reasonable to expect buyers to update their investment processes as more SLBs arrive on screens, suggesting these difficulties would be more like a teething problem than a long-term feature of the market.

“As we see more issuances, we will see even better performances in terms of issue sizes and book sizes,” said Jurkschat at DKB. “I see a lot of potential in the new asset class.”

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It was clear when Enel, the Italian power and gas company, launched the first sustainability-linked bond in September 2019 that this was a powerful concept, likely to attract strong interest. But the growth since the second issuer, Brazilian paper group Suzano, appeared in September 2020 has surprised even enthusiasts.

Research by Nordea counted 38 deals by March this year — more than half of them had come in the past three months.

“All the ingredients are there for the market to continue to grow at a rapid pace,” said Mitch

Reznick, head of research and sustainable fixed income at Federated Hermes in London.

Pointing to demand from issuers and investors, the establishment of market guidelines and the European Central Bank now being willing to include SLBs in its bond buying programmes, he said: “From almost every corner of the capital markets the conditions are ripe. The reason why it is really interesting is not all companies have specific green projects

Learning by doing: SLBs to surge, though role still needs defining

Sustainability-linked bonds are the hot capital markets product of

2021, and are developing so fast that even specialists in the field

find it hard to keep up with the pace. The market has benefited

from the very early definition of guiding principles last year but,

writes Jon Hay, big questions remain about what the instrument

is for and how it should be governed.

All the ingredients are there for the

market to continue to grow at a

rapid pace.

~ Mitch Reznick

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that can be financed with a green bond, but the core of their business is evolving — they recognise the importance of being seen as leaders in decarbonising.”

JP Morgan has been quoted as predicting issuance will reach $120bn-$150bn this year. This week, S&P said it expected sustainability-linked loan and bond issuance together to top $200bn in 2021. Up to April 9, using Bloomberg data, it said there had been $13bn of SLBs — already beating last year’s $11bn — and $46bn of loans.

More impressive even than the volume is the diversity of the market. SLBs have been issued in the US, Brazil, India, Japan, Singapore and many European countries. Last week China’s corporate bond regulator published guidelines for SLBs and already eight issuers are ready to launch deals.

Sectorally, too, they are a complete mixture, taking in supermarkets, telecoms, property, clothes retail, shipping, agricultural commodities. China’s first deals will come from the energy, cement, steel and even coal industries — a clear sign that the government sees SLBs particularly as supporting sustainability in areas of the economy with high greenhouse gas emissions.

Breakneck speedThis eruption of activity is radically different from the slow, quiet gestation of green bonds, where it took six years before investment banks got together in 2013 to define the Green Bond Principles.

The SLB market got its principles much

more quickly: the GBP organisation published Sustainability-Linked Bond Principles in June, widely cited as having given issuers confidence to bring deals.

But although the SLBP are much more detailed and rigorous than the GBP were at first, they have not answered all market participants’ questions. Far from it — any conversation about SLBs is full of uncertainties about how issuers will use them and what investors will accept.

Even if a rulebook exists, the market is still learning by doing.

In mid-April, many environmental, social and governance specialists at investment banks and asset managers were blindsided when Berlin Hyp launched the first SLB from a financial institution. 

They had thought it would take much longer for a bank to work out how to choose a key performance indicator (KPI) that met the SLBP’s quite demanding criteria: relevant, core and material to the business; measurable; externally verifiable; and able to be benchmarked against other organisations.

Issuers are very much leading the expansion of the market, as they did with green bonds. But as more firms — and potentially local or national governments — join in, the field is likely to grow more diverse, before it becomes more orderly.

Trisha Taneja, head of ESG advisory for origination and advisory at Deutsche Bank in London, expects strong growth in sustainability-linked issuance this year, from high yield and investment grade corporate

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issuers. “We are seeing more demand for social deals,” she said. “It’s becoming a clear focus for funds. It will also come from US corporates, because it’s such an important issue there.”

Emerging markets, she added, would be “the next big thing” in sustainability-linked finance, as there was strong demand from corporate issuers, especially in Asia and Latin America. “Eastern Europe and the Middle East are less penetrated markets, but I expect we will see growth there,” she said.

Although the product has been introduced for financial institutions and a government is likely to try it soon — Uruguay has been thinking about it since 2019 — market participants are wary of expecting much from those quarters.

Jacob Michaelsen, head of sustainable finance advisory at Nordea Markets, believes Berlin Hyp is a special case, because of its homogeneous loan book — commercial mortgages, mainly in Germany. It is fairly easy to calculate the carbon emissions of commercial properties.More generally, SLB issuance will remain difficult for banks, Michaelsen thinks, because of the difficulty of calculating the carbon emissions of more diverse balance sheets. Many companies do not report their carbon emissions. Banks will eventually have to report their Scope 3 emissions, and in the interim, can use estimates. But it is not clear whether investors would accept these as the basis for an SLB.

Coherence wantedSome investors, at least, are enjoying this tide of novelty. Bankers have noticed them being

particularly keen to spend time analysing SLBs that offer something eye-catching in their KPIs, rather than the more familiar greenhouse gas emission targets. Swedish clothes retailer Hennes & Mauritz was a clear example: it linked its financing partly to increasing its use of recycled materials. Supermarket group Ahold Delhaize won favour by including a KPI on reducing food waste.

But investors and bankers do not want SLBs to become a free-for-all. They are anxious that it should be a respectable, solid and coherent market. It’s just that there is no consensus yet on what that will look like.

Some see SLBs as a lower tier of sustainable finance, with green bonds remaining the gold standard.

“There seems to be a bit of a battle over the label which light green issuers could go for,” said Bram Bos, who runs one of Europe’s largest green bond funds at NN Investment Partners in the Hague. “Initially it was transition bonds, now it looks like SLBs could be a more useful tool for them.”

SLBs could be “a short term solution, for issuers who could find it difficult, to participate in the sustainable finance market,” Bos said. But they do not meet NN’s green bond criteria and Bos has reservations about the instrument. “Comparability is difficult, the step-up coupons are small and should there be a step down? The market would benefit from more standardisation. Pretty clearly, it is quite uncharted territory, like green bonds in 2013 or 2014. There probably is a future for them, but there’s more work to be done.”

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Hands and heartsThe sense that the market is only at the beginning of learning how to assess and compare the sustainability benefits of deals is widespread.

Michaelsen believes SLBs will be big, but said that “for a long time in the green bond market we have focused on transparency and impact, but for SLBs I would add another adjective: we should be sincere in what we’re trying to do.”

The sincerity of a company’s commitment to transition and improvement was the heart of these deals, he argued. But their nature creates a risk of insincerity, or the suspicion of it.

“Green bonds, compared to SLBs, are less complex — it’s a bit easier to be focused on whether assets are green,” Michaelsen said.

Defining what was sufficiently ambitious for SLBs could be difficult. Michaelsen pointed to Schneider Electric, ranked in January the most sustainable company in the world by Corporate Knights. One of the KPIs for its SLB was the CO2 emissions saved and avoided by customers using its products — something companies now call their “carbon handprint”.

“The KPI is directly related to them selling more stuff — it’s hardly a difficult argument for them,” Michaelsen said. “But is it really going to change the company? However, you need to look at the context, so the handprint argument looks more relevant when balanced against the other KPIs.”

This is exactly the kind of almost philosophical discussion that SLBs readily provoke.

Investment or strategy?Even the fundamental purpose of SLBs is still up for debate. The structure’s central breakthrough, compared with green bonds, is severing the link between an organisation wanting to issue sustainable debt and the amount of expenditure it needs to make to bring about its sustainability objective.

But Hans Biemans, head of sustainable markets at ING in Amsterdam, said he thought investors would not want the two to become completely separated. “The amount of sustainable issuance should be in sync with the quantity of investments, capex or opex, a company is doing,” he said.

It need not be a precise, one-to-one link as with green bonds, but if a borrower issued 30% of its debt as SLBs, it ought to be able to show that at least 30% of its business was green, he argued.

This idea might seem surprising, coming from ING, a bank that has been central to the growth of sustainability-linked loans, the product on which SLBs are based. SLLs have mushroomed, with $260bn signed in 2019-20, according to Bloomberg, precisely because they allow companies to engage in sustainable finance without needing to have a specific large quantum of green expenditure that can be linked to a green debt instrument of the same size.

But Biemans said most SLLs were revolving credit facilities, whereas bonds were refinancing instruments. “It’s a fundamental principle when you label money as green that it should be used in a certain way,” Biemans said. “Investors were already able to assess the KPIs of a company, its direction of travel on sustainability and

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decide if they like it. In the end, if you put a label on a bond, it should add value, compared to the regular disclosures of the issuer.”

Biemans is sure SLBs will boom, but thinks it will be a better, if smaller, market if issuers avoid the temptation to “think SLBs are an easier way to go than traditional green bonds... because in the end, investors always ask issuers about their investment plans. Whether it’s expressed in a euro or dollar amount or a KPI, it doesn’t matter.”

Reznick’s view is not too far from this — he said he did not expect to know the specific use of funds from an SLB, “but what we would like to see is that there is a capital expenditure allocation to support the transition — how are you going to get there? The strongest ones have a story of exactly how they are going to get to their targets.”

As an impressive example, he pointed to a high yield deal for Picard, the French frozen food group, which had been marketed recently. It was pulled for pricing reasons, but he expected it to come back.

For Reznick, however, the main value of an SLB is not how the money is spent. “SLBs force companies to have KPIs and targets,” he said. “It’s a self-reinforcing mechanism that makes them state their intentions and keep to them.”

Value throughout the curveBecause of this, all the bonds of an SLB issuer, not just the SLB, ought to become more valuable if the existence of the SLB makes the company try harder to meet its targets — something Enel acknowledged right at the beginning. This could create value

opportunities in the non-SLBs, which astute investors may pick up. It is vital, Reznick said, “to never be a forced buyer of anything. You would be forsaking your fiduciary responsibility if you buy securities with mispriced credit.”

It was attractive to investors to buy bonds in the primary market, because they could obtain new issue premium, and buying in secondary for more than €1m or €2m was often prohibitively expensive, Reznick said. However, investors needed to be alert to the danger that “an SLB could be chased by thematic funds, and there is a risk of a greenium being attached.”

Meanwhile, the chance of getting a greenium is one of the strongest cards banks hold when pitching the structure to issuers.

“I expect to see more issuance coming from under-represented sectors, like industrials,” said an ESG banker in London.

An industrial company issuing an SLB could expect to have a “higher than average” pricing benefit relative to its conventional curve, she said, as its rarity and new story would garner lots of investor interest.

“The continued pricing advantage towards ESG bonds is something that is agnostic between use of proceeds and SLL format,” the banker said. “It’s driven by the underlying technical of massive amount of demand for ESG.” The greenium was on average about 7bp in euros and 5bp in dollars, she said.

Just like green bonds, SLBs now inhabit a creative grey area where both issuers and investors believe they are getting good value from them.

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Berlin Hyp removed any language about “bail-in” from the contracts for its market-opening SLB last week, as a way of avoiding any debate as to whether the preferred senior debt could count towards the minimum requirements for own funds and eligible liabilities (MREL).

Most European banks are not really in a position to replicate this approach, because the bulk of their funding needs revolve around MREL and capital targets.

The market has therefore been crying out for guidance from regulators like the EBA, which

could determine whether banks can issue SLBs as anything other than straight funding products.

Some market participants thought the EBA would shed more light on its position within the next few months.

But the authority told GlobalCapital that it needed more time to think about how SLBs would sit with EU rules on capital and MREL.

“We know there are sustainability-linked bonds

EBA attempts to put brakes on FIG SLBs

The European Banking Authority has warned issuers against

rushing into the sustainability-linked bond market, as it works on

deciding whether the structures conflict with eligibility criteria

for capital and other loss-absorbing instruments. Despite the

warning, market participants are pushing hard to make sure

banks are able to issue SLBs in any format, writes Tyler Davies.

We know there are sustainability-

linked bonds coming, but for the

time being we want to send a

cautious message to issuers.

~ Delphine Reymondon

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coming, but for the time being we want to send a cautious message to issuers,” said Delphine Reymondon, head of the liquidity, leverage, loss absorbency and capital unit at the EBA.

“We will continue to do work in this area and we are looking at whether some of the features of the instruments could conflict with eligibility criteria.”

The problem is that SLBs carry a number of features that might raise red flags in respect of the regulation governing bank debt issuance.

Issuers generally commit to achieving a clear sustainability goal when they sell an SLB. They then agree to pay a penalty if they miss their objective, often in the form of a coupon step-up.

Step-up coupons are outlawed in MREL rules when they coincide with a call option, because this is said to create an unwelcome incentive for an issuer to redeem the bonds before they mature.

But market participants are unsure whether this would apply to deals with step-ups based on ESG targets, particularly if there were no call options embedded in the bonds at all.

There is also a lot of uncertainty over whether ESG objectives are material to a bank’s credit position, given the Capital Requirements Regulation forbids interest payments from varying on the basis of a borrower’s “credit standing”.

“Generally, we do not like to see links between the fulfilment of certain targets — being sustainable ones or other types — and the performance of a bond,” Reymondon said.  

“But we want to take a bit more time to investigate this specific aspect of sustainability-linked debt and possible diverse structures before making our final decision.”

The holy grailDespite the EBA’s caution, market participants are still intent on finding a solution to the MREL and capital problem for bank SLBs.

The feeling is that regulatory guidance is highly desirable, but it is not a prerequisite to issuance.

Banks are therefore trying frantically to come up with an SLB proposal with a solid legal argument, which they could then bring in front of the EBA or equivalent national authorities.

“We would likely need a legal view on structure eligibility as a minimum requirement,” explained one bank funding official. “Clearly some guidance from the regulator would be beneficial too, but this would likely only be forthcoming in the context of a specific project or with the backing of a legal opinion.”

Plenty of ideas have been swirling around investment banks and legal firms in recent months but, even so, a breakthrough might not lead to an explosion of issuance, as many issuers are also grappling with tough questions about how to develop sustainability targets for SLBs.  

But the block on banks selling these instruments as regulatory debt is seen as a barrier that must fall before the market can develop any sort of size.

“You will not find too many banks that purely need to raise funding, but there are still MREL needs and refinancing requirements,” said a FIG DCM banker. “Getting SLBs done in MREL format is therefore the holy grail.”

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Are we there yet?The same banker said he felt “reasonably comfortable” about the possibility of dispelling any concerns over whether sustainability KPIs form part of an issuer’s “credit standing”.

“Fundamentally, ESG objectives are not intrinsic to a bank’s underlying business model and we don’t think they should be seen as being linked with an issuer’s credit standing,” he said.

But questions about whether SLBs create an “incentive to redeem” are much trickier and could depend on the exact shape of the instrument being proposed.

Some investment bankers are shying away from the idea of using coupon step-ups and feel safer with step-downs or cash premiums to be paid upon the redemption of the bonds.GlobalCapital understands that one bank even

discussed plans to gift funds to charity in the event that it missed the sustainability targets in its hypothetical SLB. 

Other firms are more determined to keep the step-up structure, because of its simplicity.

To get around the regulatory uncertainty, they have instead talked about including the step-up at a point before any call options come into play.

Banks could also simply issue bullet structures, though this would only work for senior bonds and tier two debt and it would be less efficient from a cost/benefit perspective. 

Even then, regulators could still have concerns about “incentives to redeem” even if an SLB has no call option, because borrowers would still be able to buy their bonds back from the market.

“We think we could make the instruments even more robust by contractually restricting the possibility of buy-backs,” said the same FIG DCM

banker.  The funding official said: “We don’t seem to be there yet but there does seem to be lots of motivation to solve the issues on structuring.”

A two-step processThe EBA held a roundtable for issuers last week at which it briefly discussed some of the main questions around bank SLBs. But the bulk of the conversation centred on issuance in the more traditional “use of proceeds” format.

The authority will move forward in two steps with respect to its guidance on ESG bond markets, Reymondon told GlobalCapital.

“Firstly, we want to clarify what terms and conditions banks should include in their ‘use of proceeds’ bonds,” she said. “Then we want to take a little more time to look at sustainability-linked bonds, with a particular focus on links between targets and investor remuneration.”

The EBA intends to put out some public guidance about “use of proceeds” bonds before the summer, possibly through its next additional tier one monitoring report.

The guidance is likely to build on what the authority said in its MREL monitoring report last October.

It raised its concerns about “a possible perception by investors that green assets and green capital could be segregated from the rest of the assets and capital” of an institution.

“We want banks to be clear that their bonds are capital or MREL instruments before they are green/ESG instruments,” Reymondon said.

“Investors should know that deals can absorb losses wherever they come from on the balance sheet and that instruments cannot just be redeemed if the issuer runs out of green assets.”

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Loans are the private siblings of bonds, happy to stay out of the limelight, with companies usually only willing to disclose a bare bones outline of their bank facilities — size, maturity and, less frequently, the full banking group and pricing.

With the rise of sustainability-linked lending over the last few years, borrowers have also had some new information that falls into the must-reveal bracket — the key performance indicators that will determine whether their loan margin rises or falls. Not all KPIs are created equal, and the privacy that the loan

market normally prides itself on is damaging the sustainability-linked loan market at a crucial time in its development.

Take Vestas’ €2bn debut. The Danish company will benefit from a lower margin if it reduces carbon emissions in its supply chain while increasing workplace safety, its usage of sustainable materials and how recyclable its products are. 

No mention by Vestas of how much it needs to increase or decrease these metrics by to get

Corporates must be more transparent on sustainability-linked loans

By being allowed to hide the details of sustainability targets and

incentives, Europe’s investment grade corporations are being

given an easy ride when it comes to sustainability-linked loans.

They must be more open if the market is to remain credible.

With the rise of sustainability-linked

lending over the last few years,

borrowers have also had some new

information that falls into the must-

reveal bracket

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the pricing benefit, and a spokesperson refused to provide further illumination, citing “privacy concerns”. 

Compare that to the UK’s McBride, which on Tuesday gave fuller details of the KPIs for a new €175m bank facility. For the company to see a margin improvement, it must, among other things, increase the percentage of its energy that comes from renewable sources to 70% by 2026.

For years, lenders have insisted that they should be trusted as the gatekeepers of the sustainability-linked market, and that they would not allow standards to slip. Some imply that they see it as a moral duty, as well as a professional one.

But in the hyper-competitive world of investment grade loans, banks are forever looking for an advantage over their rivals. Pricing has long been nonsensical if taking a loan as a standalone product, and the hope at the start of this year that the coronavirus pandemic would create a shift to three year loans instead of five as standard proved to be short lived.

It would make sense, then, that banks might

look to compete on what they would consider acceptable KPIs for a sustainability-linked loan, particularly as the definitions are not tightly policed, unlike risk-weighting, for example, which tightly restricts how much a bank can lend and to whom.

From the borrower’s perspective, if they are offered sustainability-linked deals from two competing clubs of banks, one of which features KPIs that are much easier to reach, and with them that feel good moment of publishing a press release to tell stakeholders how environmentally friendly they are, the choice would seem obvious.

It’s not outlandish to suggest that companies should publicly disclose the terms of their KPIs — in the US, publicly listed companies routinely disclose the full terms of their sustainability-linked loans, and much more, in SEC filings.

For the sake of Europe’s sustainability-linked loan market, banks need to push borrowers to make the KPIs public, including the percentage change needed and from what baseline level. Otherwise, competition could easily overtake principles, and the market runs the risk of losing the most important thing it has — credibility. 

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“It sends a really strong message that it did well, because the concept of investment companies doing SLBs will be a broadening topic,” said Anjuli Pandit, primary markets sustainability manager at BNP Paribas, one of the deal’s bookrunners. “So it’s interesting to see how well received it was. This week we’ve had Imerys, a minerals company, Weir, serving the energy industry, Verallia, a bottling company — it shows the phenomenal flexibility this product offers. So it’s really exciting to see it could even

work for a financial company.”The Swedish private equity firm, which

has €67bn of assets under management and floated in Stockholm in 2019, is chaired by Conni Jonsson (pictured). The firm has been interested in sustainability for some years — it published its first responsible investment report in 2014 and has been issuing GHG emissions reports since 2015. 

EQT mixes CO2 and diversity in first SLB from private equity

EQT achieved a strong response from investors on Friday when

it launched the first sustainability-linked bond from a private

equity firm, and only the second from a financial company. The

€500m deal is tied to greenhouse gas emission cuts and gender

diversity metrics.

They met a good variety of

investors, including some who

wouldn’t normally invest in private

equity but were attracted just by

the ESG angle.

~ Anjuli Pandit

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EQT defines this responsibility not just in terms of optimising its own risk and return.

“EQT AB believes that each EQT Fund should use its role as a main shareholder in… portfolio companies to further combat climate change,” the firm said in its Sustainability-Linked Financing Framework.

Last June it obtained a €2.3bn equity bridge loan with sustainability criteria, the largest of its kind.

The bond builds on that financing. EQT has committed to three key performance indicators, each of which can separately trigger a coupon step-up if it fails, up to a total of 25bp.

By the end of 2023, EQT will have installed targets, validated by the Science-Based Targets Initiative, to reduce its Scope 1, 2 and 3 greenhouse gas emissions. Scope 3 includes investments, in other words, its portfolio companies. The step-up is 10bp for this, 7.5bp for each of the other two.

Science-Based Targets are becoming seen as a gold standard in the SLB market for assessing whether companies are reducing emissions fast enough.

EQT is “trying to push all their portfolio companies to demonstrate a pathway to the Paris Agreement,” said Pandit. “It’s quite difficult for an investment firm. Investors can appreciate that, because they’re trying to do it with their own investments, so it was something quite well received.”

The second KPI is that by the end of 2026, at least 28% of EQT’s own eligible investment advisory professionals will be women. 

This is to address the under-representation of women in private equity. EQT said in its Framework that it had “ambitions to progress the broader diversity, equality and inclusion agenda — for now, only gender is measurable enough to report on”.

In 2018, 14% of these professionals at EQT were women — last year 21% were.

Also by end-2026, the percentage of independent directors at EQT’s portfolio companies who are women should be 36%, up from 22% now.

“It’s great they had a gender target,” Pandit said. “I think there will be a lot of interest from other issuers wanting to know what is the right target to use, so it’s a great use case.”

Goldman Sachs and Morgan Stanley were ESG structuring agents on the bond, a role BNP Paribas and SEB fulfilled on last year’s loan.

The loan had three KPIs too, all relating to portfolio companies: gender equality on the board of directors, renewable energy transition and having a fundamental sustainability governance platform.

EQT had been marketing the bond publicly since announcing it on Tuesday. Besides Goldman and Morgan Stanley, the global coordinators, BNP Paribas, Nordea and SEB are bookrunners. Deutsche Bank and DNB are co-managers.

“They met a good variety of investors, including some who wouldn’t normally invest in private equity but were attracted just by the ESG angle,” said Pandit.

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The €500m no-grow 10 year bond, rated A- by Fitch, was announced on Friday morning at initial price thoughts of 110bp over mid-swaps. The deal has a three month par call, 80% clean-up call and change of control covenant.

At 11.30 UK time the leads said the book was over €1.5bn and gave guidance of 85bp-90bp, will price in range. The order book was to go subject at noon.

At 12.30, the spread was set at 85bp, with €1.7bn of orders good at the guidance. The final book was €1.5bn. The bond was priced at 99.203 with a 0.875% coupon to yield 0.959%.

“They had a healthy mix of domestic and broader European investors,” Pandit said, “and enough put it in ESG funds to show that there was a positive response from the ESG side.”

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DCM bankers have been expecting an announcement about the deal from Uruguay for some time. It is the only Latin America investment grade government not to have issued so far in 2021 amid another bumper year for sovereign issuance in the region.

Bank of America, HSBC and Santander are leading the Baa2/BBB/BBB- rated sovereign’s proposed deal, which will comprise a dollar and nominal peso bond. Both tranches will be of benchmark size, with intermediate maturities,

and some proceeds may be used for liability management purposes. 

In 2020, as most LatAm sovereigns loaded up on foreign currency debt to meet their pandemic funding needs, Uruguay bucked the trend. In June last year, it tapped its dollar 2031s for just $400m alongside issuing a $1.6bn-equivalent peso-denominated inflation-linked amortising 2040 bond. This week, Uruguay is looking to return to the nominal

Uruguay mandates for pesos, dollars as SLB plans evolve

Uruguay began investor calls on Monday ahead of a proposed

dollar and global local currency bond issue. The marketing effort

came as the government continues to take steps towards issuing

what would be the first sustainability-linked bond from any

sovereign — though this week’s expected deal will not have ESG

characteristics.

In 2020, as most LatAm sovereigns

loaded up on foreign currency debt

to meet their pandemic funding

needs, Uruguay bucked the trend.

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peso bond market — which it only tapped for the first time in 2017 after bringing persistent inflation under control.

As reported in February, the debt management unit is continuing its focus on local currency issuance as it aims to increase peso share of its debt stock from 45.7% to 50% by the end of this administration, in 2024. 

Two of Latin America’s better rated sovereigns, Peru and Chile, have had to increase the foreign currency share of their funding during the pandemic as their domestic markets come under severe pressure.

However, Uruguay’s relative resilience to Covid-19, coupled with — as mentioned in the investor presentation — social and political stability that few LatAm countries can boast, has led Uruguay to outperform the rest of the region over the last year. 

According to Uruguay’s roadshow presentation, the government has $4.486bn of financing needs in 2021 — of which $3.86bn will come from financial markets. Despite a surge in cases in recent months, Uruguay has still suffered far fewer coronavirus deaths per capita than any of its Latin American peers, and the fiscal deficit only deteriorated from 4% of GDP in 2019 to 5.8% last year. The government recently revised the 2021 deficit forecast from 4.7% to 4.1%.

Though Uruguay is rated lower than Peru and Mexico, and in line with Panama, the only LatAm sovereign with lower average dollar bond spreads tighter than Uruguay is Chile. Uruguay’s 4.375% January 2031s, first issued in 2019, are trading at a spread of 82bp

over US Treasuries, according to data from MarketAxess. 

Herman Kamil, director of Uruguay’s debt management unit, is leading the roadshow team alongside Antonio Juambeltaz and Victoria Buscio, both lead advisors at the unit.

SLB still in the works GlobalMarkets, GlobalCapital’s sister paper, first revealed in 2019 that Uruguay was weighing up how to integrate ESG credentials into its bond issuance in a way that went beyond the green use of proceeds format used by other sovereign issuers.

In February, GlobalCapital revealed that Uruguay was considering the issuance of a sustainability-linked bond (SLB) — as pioneered by Italy’s Enel in 2019 and now becoming ever more commonplace across corporate bond markets. 

As it prepares its latest international deal, Uruguay is advancing its SLB plans. Kamil said on Monday’s roadshow presentation that the government was “committed to integrating climate policy into economic decisions”.

In a newsletter sent to investors on Friday, the sovereign offered hints of how the SLB plans were evolving. The finance ministry is working alongside the ministry of environment, the ministry of industry and energy, the ministry of agriculture and cattle raising, and the office of budget and planning in the design of a potential sovereign issuance “tied to sustainable goals based on the country’s international commitments on climate change”. 

In October, Uruguay joined the Coalition of

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Finance Ministers for Climate Action. The Helsinki Principles, coalition’s guiding values, were explicitly incorporated into Uruguay’s 2020-2024 budget law.

Last month, the ministries of finance and of industry and energy launched a “national roadmap” for green hydrogen. Already, Uruguay is a leader in wind energy, with 90% of its electricity coming from renewable sources. The green hydrogen plan is what the government is calling the “second transition” of its energy matrix. 

Kamil had told GlobalCapital in February that some of Uruguay’s characteristics — such as renewable energy projects being carried out by state-owned companies rather than being part of the central government budget — were “potential challenges” to the sovereign issuing a traditional use of proceeds green or sustainable bond. 

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Berlin Hyp (Aa2/—/AA-) announced plans to issue an SLB last Friday, when it selected Commerzbank, Crédit Agricole, DZ Bank, HSBC and LBBW as its joint lead managers.

It was the first time a bank had set out an approach the asset class, which has been growing in popularity among corporate issuers.

The basic idea behind an SLB is that firms will commit to compensating investors if they cannot meet pre-defined ESG targets within an agreed timeframe.

Market participants were interested to see

whether Berlin Hyp could command more pricing power through the offer of a coupon step-up on its SLB, which came in the form of a €500m 10 year preferred senior bond.

“The sustainable features may contribute to tighter trading levels versus vanilla debt in our view,” said Suvi Kosonen, a strategist at ING Research, ahead of the sale.

The lead managers set out with price thoughts in the 50bp area over mid-swaps

Berlin Hyp draws blueprint for bank SLBs

Berlin Hyp has this week become the first financial institution

to issue a sustainability-linked bond. Market participants were

divided over whether the structure helped the issuer to achieve

better deal terms, but the innovative trade will give other banks

an important example to follow.

We know there are sustainability-

linked bonds coming, but for the

time being we want to send a

cautious message to issuers.

~ Delphine Reymondon

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when they opened the order books on Tuesday morning.

There were no immediate signs of a blowout transaction, with demand reaching a total of just €800m by 10.20am in London.

The book had only grown slightly by midday, when it stood at €850m, lifted by €133m of demand from the joint lead managers themselves.

Berlin Hyp then set the final spread for its €500m 10 year preferred senior deal at 35bp, having tightened by a total of 15bp. Final demand reached €790m, including the lead manager interest.

A banker away from the transaction claimed the German lender “didn’t get any pricing benefit from issuing its trade as an SLB bond”.

Berlin Hyp’s own €500m 0.5% November 2029 green senior bond was spotted at about 15bp over swaps at the end of last week, though bankers said this level was artificially tight and that the bond was an unsuitable comparison.

Market participants were therefore focused on senior paper from other highly rated issuers. Crédit Agricole, Erste Bank, Nordea, OP Bank and Rabobank, for example, had deals with tenors of between six to 10 years trading in a range of about 28bp-41bp.

The same on-looking FIG banker thought fair value was probably in the low to mid 30bp, based on where these transactions had been trading.

A banker at one of the leads broadly agreed with this fair value assessment, but he argued that the SLB format had helped with the

execution of the deal on Tuesday. He said that demand was always going to be

hampered by the fact that a high-quality credit like Berlin Hyp cannot offer much of yield to investors, even at the long end of the curve.

“We got more demand by doing an SLB than we would have done if it were a conventional transaction,” the banker said. “Even at such a tight spread, we still had great demand from investors.

He added: “Berlin Hyp has shown that SLBs can be done in FIG. That is a very positive message for the market. This will not be a one-off.”

Stepping up to the plateBerlin Hyp has an ambitious sustainability performance target (SPT) embedded in its SLB. 

It has pledged to decrease the carbon intensity of its entire loan book by 40% by the end of 2030, which means it is taking responsibility for the carbon dioxide emissions produced by the commercial real estate it finances. 

If the issuer cannot meet its SPT then it will increase the very last coupon on its €500m 10 year by 25bp.

Lead managers said that some investors commented on the SLB’s penalty structure during the roadshow.

The funds had questioned why Berlin Hyp was only offering an extra 25bp, given that some corporate issuers have paid more when including last minute step-ups on their SLBs.

But most market participants were very happy with size of the penalty payment, which

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represents more than 70% of the overall spread on the deal.

“The market will evolve with different step-ups,” said the lead manager, who noted that 25bp would not necessarily become any kind of standard for the FIG market. “This will have to be based on the issuer’s sector, the tenor of the deal and the rating.”

A second banker on the transaction noted that the decision to fix the target in 2030 was very deliberate, because it is aligned

with emissions targets described in the Paris Agreement and Germany’s own “Climate Paths”.

Berlin Hyp has also committed to reporting on its progress towards two interim targets: a 14% drop in the carbon intensity of its loan book by 2025 and a 27% fall by 2028. 

The issuer could use these interim targets in the future to help it structure shorter term SLBs, GlobalCapital understands.

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