Chanel, Tesco and the rise of sustainability-linked financing

When lux­u­ry fash­ion brand Chanel issued €600 mil­lion of bonds last Sep­tem­ber, there was an unusu­al catch: if the com­pa­ny fails to meet its sus­tain­abil­i­ty goals, it will have to pay penal­ties to investors.

The deal is an exam­ple of a new type of debt known as a sus­tain­abil­i­ty-linked bond, which is a way for busi­ness­es to finance them­selves while tying repay­ments to their sus­tain­abil­i­ty tar­gets. That is dif­fer­ent from tra­di­tion­al green or sus­tain­abil­i­ty bonds, where the mon­ey raised has to be spent on a spe­cif­ic green or social project.

“Sus­tain­abil­i­ty-linked bonds essen­tial­ly help com­pa­nies cre­ate an ambi­tious and account­able path­way to sup­port their over­all sus­tain­abil­i­ty strat­e­gy,” says Del­phine Que­niart, glob­al head of sus­tain­able finance and solu­tions at BNP Paribas Glob­al Mar­kets.

Chanel’s bond sale con­sist­ed of two sep­a­rate deals for €300 mil­lion each. The first com­mits the com­pa­ny to cut­ting its green­house-gas emis­sions in half by 2030 and reduc­ing emis­sions in its sup­ply chain by 10 per cent. The sec­ond pledges to tran­si­tion to 100 per cent renew­able elec­tric­i­ty across the company’s oper­a­tions by 2025.

If Chanel fails to meet its emis­sions tar­gets, it will have to pay a cash penal­ty of 0.75 per cent, almost dou­bling the 1 per cent inter­est rate it is pay­ing to bor­row the mon­ey. Like­wise, if it fails to meet its renew­able elec­tric­i­ty tar­get, it will have to pay an addi­tion­al 0.5 per cent pre­mi­um on top of the 0.5 per cent inter­est rate for that bond.

In addi­tion to emis­sions tar­gets and renew­able ener­gy goals, some issuers have includ­ed tar­gets relat­ed to diver­si­ty. Schnei­der Electric’s deal in Novem­ber 2020, for instance, includ­ed a tar­get to improve gen­der diver­si­ty across its busi­ness so that by 2025 women will account for half of all new hires, 40 per cent of front-line man­agers and 30 per cent of its lead­er­ship teams. It has also com­mit­ted to train­ing one mil­lion under­priv­i­leged peo­ple in ener­gy man­age­ment by 2025.

“A few years ago it wasn’t that easy to hold com­pa­nies to account and track their ESG [envi­ron­men­tal, social and gov­er­nance] improve­ments, but sus­tain­abil­i­ty-linked bonds will help you to do that,” says Mark Munro, fund man­ag­er at Stan­dard Life Invest­ments. “These will help move the con­ver­sa­tion for­ward; it’s much bet­ter to think about a holis­tic ESG tar­get for a com­pa­ny rather than just a spe­cif­ic project.”

Ital­ian ener­gy com­pa­ny Enel issued the first sus­tain­abil­i­ty-linked bond in 2019, tak­ing a cue from the loan mar­ket where inter­est rates could be ratch­eted up or down depend­ing on whether or not cer­tain met­rics had been met. That remained the only deal until last year, when the intro­duc­tion of the Inter­na­tion­al Cap­i­tal Mar­ket Association’s Sus­tain­abil­i­ty-Linked Bond Prin­ci­ples, which pro­vide guide­lines around how the bonds should be struc­tured, spurred more com­pa­nies to fol­low suit. 

Chanel, Novar­tis and Suzano! all issued bonds in Sep­tem­ber 2020, with more deals fol­low­ing in Novem­ber after the Euro­pean Cen­tral Bank said it would accept sus­tain­abil­i­ty-linked bonds as col­lat­er­al.

In total, com­pa­nies issued rough­ly $9 bil­lion of sus­tain­abil­i­ty-linked bonds in 2020, accord­ing to Ángel Teja­da, head of the green bonds group at Span­ish bank BBVA. He believes there could be any­where up to dou­ble that amount issued over the com­ing year.

“We will like­ly see issuers try­ing to com­ple­ment their green bonds with sus­tain­abil­i­ty-linked bonds because they offer more flex­i­bil­i­ty and less lim­i­ta­tions on what they can spend the pro­ceeds on. But we are also like­ly to see new issuers that aren’t able to fund suf­fi­cient eli­gi­ble assets to issue a green bond, but want to engage with ESG investors,” says Teja­da.

Tesco was one of the first com­pa­nies to tap the mar­ket this year, issu­ing a €750-mil­lion sus­tain­abil­i­ty-linked bond in Jan­u­ary that com­mits the super­mar­ket chain to a 60 per cent cut in its green­house-gas emis­sions by 2025.

While bankers pre­dict the vol­ume of sus­tain­abil­i­ty-linked bond issuance could even­tu­al­ly match the green bond mar­ket, which accord­ing to Dealog­ic saw $235 bil­lion of deals last year, they also cau­tion against mov­ing too fast.

“It is impor­tant for us how these bonds are struc­tured, that the tar­gets are ambi­tious and cred­i­ble so there is no green­wash­ing,” says Que­niart at BNP Paribas. “We pre­fer there is a con­sid­ered pace of shap­ing the mar­ket, rather than peo­ple quick­ly set­ting non-cred­i­ble tar­gets, which may erode con­fi­dence in the nascent mar­ket.”

Rep­u­ta­tion­al risk could also damp­en poten­tial issuance giv­en that if a com­pa­ny failed to meet its sus­tain­abil­i­ty goals, it could attract neg­a­tive pub­lic­i­ty and dis­cour­age oth­ers from pur­su­ing deals.

“If you set your­self high tar­gets and miss them, and then get crit­i­cised for it, that will ulti­mate­ly hurt the devel­op­ment of the mar­ket,” says Clare Burgess, part­ner at Clif­ford Chance.

Some com­pa­nies are also ques­tion­ing the val­ue of reward­ing investors for miss­ing tar­gets. For exam­ple, Hong Kong real-estate group New World Devel­op­ment issued a sus­tain­abil­i­ty-linked bond at the start of this year, which instead of pay­ing investors a high­er inter­est rate if it fails to meet its tar­get will spend the equiv­a­lent amount of mon­ey to buy car­bon off­sets.

While it is too ear­ly to gauge how much impact sus­tain­abil­i­ty-linked bonds will have on broad­er efforts to achieve net-zero emis­sions by 2050, the devel­op­ment of the mar­ket is part of a wider ESG trend that is reshap­ing how peo­ple invest.

“The real game-chang­er is the way ESG and sus­tain­abil­i­ty cri­te­ria are becom­ing embed­ded much more deeply and holis­ti­cal­ly into invest­ment strate­gies,” says Andrew Carey, co-head of Hogan Lovells’ impact financ­ing and invest­ing group. “What is poten­tial­ly far more pow­er­ful than the bonds them­selves is the more seis­mic shift in the way investors think about sus­tain­abil­i­ty.”

That deep­er ESG focus among investors is also like­ly to change how com­pa­nies approach sus­tain­abil­i­ty.

“As we’ve seen with green finance in gen­er­al, the real ben­e­fit is it ele­vates sus­tain­abil­i­ty issues to the trea­sury func­tion and board lev­el because it’s no longer just the ter­ri­to­ry of the cor­po­rate respon­si­bil­i­ty group,” says Burgess. “It makes peo­ple talk to each oth­er and that cre­ates the momen­tum behind the sus­tain­abil­i­ty changes in the busi­ness, which can have a much greater impact.”