H1 2023 European Sustainability-Linked Bonds Wrap: Sustainability-Linked Bonds Issuance Doubled in Volume in H1 2023 With Coupon Step-Up Increasing to 0.25% for Each Unmet Target

   

• Sustainability-Linked Bond Volumes Doubled: Sustainability-linked bond, or SLB, issuances in H1’23 almost doubled in volume to approximately €4.2 billion from €2.8 billion in H1’22. In terms of market share and number of deals within the European high-yield bond market, SLB issuances maintained a similar overall position compared with H1’22. This shows the continued resilience of the instrument despite volatile market conditions and concerns over its credibility.

• No Sponsor SLB Issuances: Half of the SLBs issued in 2022 and 2021 were sponsor-backed deals, but there were no sponsor SLB issuances in H1’23, despite 47% of European high-yield bonds issued being sponsor deals.

• SLBs Featured a Higher Increase to the Coupon: Sustainability terms in the first half of the year were largely similar to those seen last year, albeit with some differences. As a positive change (for investors), most first-half SLBs adopted a higher increase to the coupon for each sustainability target not met equal to 0.25%. As a negative change (for investors), fewer SLBs in H1’23 featured comprehensive pricing protections comprising an increase to both the coupon and the redemption premium.

• Express Amendment Provision Included in the Majority of SLB Documents: The European SLB market is standardizing around including express amendment provisions to allow for sustainability targets to be changed if a material event occurs. Moreover, more than half of first-half SLBs also required an issuer-appointed qualified third party to confirm the relevant changes.

• Annual Reporting in SLBs Is Increasing: The requirement for issuers to deliver sustainability reports is becoming a European market standard, with non-delivery triggering an increase to the coupon and/or redemption premium, but not constituting a default under the bonds.
   
• SLBs Care About E, S and G for the First Time: In the first half of the year, focus was on “E,” “S” and “G,” with the first European high-yield SLB issued by Eramet addressing governance issues and Teva Pharmaceuticals incorporating social targets. About 40% of SLBs focused exclusively on tackling environmental issues, principally climate change.

 
Climate change continues to affect the entire world, with extreme weather conditions such as drought, heat waves, heavy rain, floods and landslides becoming more frequent, including in Europe. The pressure to comply with the Paris Agreement to limit the global temperature increase to well below 2 degrees Celsius and to reach carbon neutrality by 2050 has become more intense as the goal to limit global warming to 1.5 degrees Celsius becomes harder to achieve.

Everyone is called upon to do better and more to tackle climate change, and sustainable finance plays a key role in mobilizing the private sector, among other things by giving financial rewards (and penalties) for the achievement (or not) of sustainability targets. SLB volumes in H1’23 almost doubled compared with H1’22, to €4.2 billion from €2.8 billion. SLB issuance maintained a similar share of the European high-yield bond market compared with the previous year, featuring in 13% of European high-yield bonds compared with 15% in H1’22 and 13% in 2022.

Earlier this year, we hoped for an increasing number of SLBs, but eventually only five SLBs came to market in H1’23, the same number as in H1’22, even though the overall issuance of European high-yield bonds increased by 215% in H1’23 compared to the same period last year. Looking forward, we hope that SLB issuance in the second half of this year surpasses the issuance in H2’22 - only one SLB so far!

Overall, sustainability terms in SLBs in H1’23 were largely similar to those seen last year (more detail on which can be found HERE). One deviation of note was an increase in the amount of the coupon penalty, or coupon step-up, on an issuer failing to meet its sustainability targets - H1’23 SLBs have predominantly included a 0.25% increase to the coupon for each sustainability target not met. In addition, fewer SLBs featured comprehensive pricing protections comprising both a coupon step-up and an increase in the redemption premium, or SPT redemption premium.

European SLBs in H1’23 continue to allow the issuer to make changes to the documentation (without expressly requiring any bondholder consent) to reflect the impact of acquisitions, regulatory or policy changes, or other similar significant events on the key performance indicators, or KPIs, or sustainability performance targets, SPTs, in the bonds, albeit not in a standardized way. Some bonds allow the issuer to exclude the impact of these events, while other bonds allow it to amend the KPIs and/or SPTs. Significantly, confirmation of the exclusions or changes by an independent third party, or external verifier, is not always required. In H1’23, except for Teva Pharmaceuticals’ 2029s/2031s, all SLBs included provisions expressly allowing an issuer to amend sustainability-linked KPIs and/or SPTs, with more than half of these requiring the oversight of an external verifier. This is similar to the landscape in 2022, and suggests that the market is moving toward the inclusion of KPI/SPT-related amendment provisions in SLB documentation as a standard feature.

The SLB market is also moving toward standardizing the requirement for issuers to deliver sustainability reports, with the majority of H1’23 SLB issuers providing them on an annual basis. However, as mentioned before, the failure to deliver these reports only results in an increase in the coupon and/or the redemption premium; it does not constitute a default under the bonds. Although sustainability reports continue to be prepared by the issuer, if delivered in conjunction with the verification of the SPTs, these reports will be required to include the assurance from the named external verifier as to the issuer’s determination of the SPTs.

The exclusive focus of SLB issuers on environmental targets and their lack of commitment with respect to social and governmental issues that we highlighted in 2022 has begun to turn in H1’23. First-half SLBs incorporated environmental, social and governance related targets for the first time since the issuance of the first European high-yield SLB in 2021. French mining group Eramet issued the first European high-yield SLB addressing governance issues (related to the decarbonization targets of its suppliers and customers) and Teva Pharmaceuticals came back to market with new 2029s/2031s also incorporating social targets (relating to product volumes and regulatory submissions in low- and middle-income countries). While not a high-yield SLB, the Republic of Chile issued the first SLB with a gender-based target, a feature that we hope will be imported into the European high-yield SLB market soon.

In this article, we look at how ESG provisions have continued to evolve in European high-yield bonds based on data from our Market Maker database and internal ESG European high-yield bonds database, which tracks more than 50 ESG-related data points. This article is based on European high-yield bonds featuring sustainability-linked provisions from Jan. 1 to June 30 - H1’23 SLBs. From time to time in this article we compare H1’23 SLBs with SLBs reviewed from Jan. 1, 2022 to Dec. 31, 2022 (2022 SLBs), Jan. 1, 2021 to Dec. 31, 2021 (2021 SLBs) and their respective half-year periods. Capitalized terms used in this article are defined in the glossary at the end of this report, unless elsewhere defined in this report.

A note of caution: Given the lighter volume of deals in H1’23 and 2022, the statistics for SLBs during these periods are more sensitive to distortion. In most instances, the statistics suggest identifiable market trends, but in a few instances showed movements that could equally be explained by data distortion.
 
Following the issuance of the first European sustainability-linked high-yield bond by Paris-headquartered aluminum maker Constellium in 2021, the European high-yield SLB market has grown considerably. New issuance in the first half of 2023 was €4.2 billion, nearly double the €2.8 billion issued in the first half of 2022. While it is tempting to attribute this increase to a heightened awareness of sustainability among issuers and investors, it needs to be considered in the context of the growth in the size of the European high-yield bond market as a whole. Within Reorg’s coverage universe, a total volume of €33.3 billion of European high-yield bonds was issued in H1’23 - more than double the €15.5 billion volume of bonds issued in the same period last year. Consequently, the SLB market has maintained a similar overall position in H1’23 in terms of share of the European high-yield bond market compared with the same periods in 2022 and 2021. SLBs made up 13% of H1’23 European high-yield bonds compared with 15% in H1’22, 11% in H1’21 and 13% in 2022 and 16% in 2021.

 

In terms of the number of SLB deals, the picture is slightly different. While five SLBs were issued in each of the first halves of 2023 and 2022, there were 15 SLB deals in H1’21 and only one in H2’22. So while the size of the SLB market has grown, its share of the broader European high-yield bond market has remained relatively constant, with the number of SLB deals in any period fluctuating with the broader market. Although we would have liked to see SLBs grow their share of the broader European high-yield market, we’re happy to settle for a show of resilience in a turbulent market.
 
Sector

As illustrated below, manufacturing and industrial sectors have consistently dominated SLB issuances, including in H1’23. This is unsurprising, as companies in the manufacturing and industrial sectors are likely to produce more greenhouse gas, or GHG, emissions compared with other sectors. There is a huge focus on ESG in limiting carbon emissions as highlighted by the seminal Paris Agreement.
 

Sponsor vs. Non-Sponsor Deals

In 2022 and 2021, the SLB market was populated by sponsor and non-sponsor deals alike. The picture in the first half of 2023 is completely different: 47% of European high-yield bonds issued were sponsor deals, yet none of them were SLBs. We are not aware of a specific reason why sponsors did not favor SLBs given that they do not require the proceeds to be used for a specific purpose like green or social bonds. One reason could be the potential reputational risks linked to the ESG strategy of a portfolio company. As an example, base chemicals producer Nobian, owned by The Carlyle Group and GIC, announced that it met its emission target under its 3.625% sustainability-linked senior secured notes due 2026, which it had been expected to miss. This raised questions about how Nobian calculated its emissions and whether it had engaged in “creative carbon accounting” (which it denies), and Carlyle, GIC and other sponsors could understandably be thinking that this is a headache that they don’t really need. However, it is worth noting that this applies to five deals only and so isn’t necessarily an indication of a broader trend.
In 2021 and 2022, the majority of SLBs issued contained a full set of high-yield covenants. The trend in H1’23 has reversed, with the vast majority of SLBs issued being “high-yield-lite” bonds lacking a number of the material high-yield covenants (e.g. asset sales, debt, liens, restricted payments and permitted investments). It is tempting to think that the prevalence of high-yield-lite SLBs in H1’23 is linked to the absence of sponsor deals, but equally the lack of the covenant protection could be explained by the fact that all of the H1’23 SLBs were assigned a double B, or equivalent, rating by Fitch, Moody’s or S&P, as these bonds tend to omit one or more of the material high-yield bond covenants. Could this be the start of a move by SLBs to the higher end of the high-yield spectrum? Possibly, but given the limited number of deals in the period that’s probably a question better answered in a year’s time.
   
A core feature of SLBs is that their financial return will vary depending on whether or not specified performance targets are met. This is typically done through an adjustment to the coupon, or coupon step-up, and/or the redemption price, or SPT redemption premium.

Sustainability terms H1’23 were largely similar to those seen last year, albeit with some differences. As a positive change (for investors), most SLBs in H1’23 had a higher coupon step-up of 0.25% for each target not met compared with the 0.125% most commonly seen. As a negative change (for investors), fewer SLBs in H1’23 providing comprehensive pricing protection of both a coupon step-up and an SPT redemption premium compared to 2022.

Step-Up Triggers and Pricing Adjustments

All H1’23 SLBs follow the European market standard, featuring a one-way pricing increase and step-up triggers based on a failure to achieve the agreed SPTs or deliver the relevant SPT documentation. Similar to 2022, in H1’23 we saw no innovation in step-up triggers or in the methodology behind pricing adjustments in SLBs.

Pricing adjustments in SLBs typically consist of (a) an increase in the coupon by a specified percentage and/or (b) a redemption premium, in both cases applied if the issuer fails to meet one or more of its targets or deliver the required SPT documentation.

In 2022, almost two-thirds of SLBs featured both coupon step-ups and an SPT redemption premium. This was a positive development for investors: if only a coupon step-up applies, and an issuer fails to meet its SPTs, it may be cheaper for the issuer to redeem the bonds than pay the increased coupon, depending on the timing of the SPTs and when the bonds can be redeemed at par.

In H1’23, the redemption premium fell out of favor with more than half of SLB issuers offering a coupon step-up only.

No H1’23 SLBs had an SPT redemption premium only.

Less than half of H1’23 SLBs included a comprehensive pricing adjustment, with both a coupon step-up and SPT redemption premium, compared with 67% in 2021 and 2022. However, this needs to be considered in the context of the redemption provisions for the bonds that didn’t include an SPT redemption premium - all of them were “make-whole for life” that can be redeemed at par only during the final three months prior to maturity. Before then, a make-whole redemption would be calculated including any coupon step-up, and accordingly the absence of an SPT redemption premium is less of a weakness.
 
No SLBs in H1’23 featured a two-way mechanism, which has only been seen once since 2021 in Vodafone Ziggo’s 2032s.

Pricing Increase Amounts

Coupon Step-Ups

At the beginning of this year, we flagged that the European market was moving toward a standardized coupon step-up of +0.125% for each SPT not met. In H1’23, most SLBs featured an even higher increase.

From a first look, the size of the coupon step-up in the first half of the year appears similar to what we saw in 2021 - ranging from +0.1% (Teva’s 2029s/2031s) to +0.5% (Nexan’s 2028s) for each SPT not met. However, on a closer inspection the picture changes.

If we exclude repeat issuer Teva Pharmaceuticals, which offered only a 0.1% coupon step-up per annum in its 2029s/2031s compared with the 0.125% coupon step-up per annum offered in its 2027s/2029s/2030s, the most common price increase in H1’23 is 0.25% for each SPT not met. This was the second most common price increase in 2021, but in 2022 it only featured in one bond - Forvia’s 2026s.

Teva Pharmaceuticals’ tiny coupon step-up could have been driven by a fear of missing its SPTs. This fear turned to reality for Public Power Corporation when it failed to meet its scope 1 GHG emissions target for the financial year 2022, resulting in a 0.5% increase of the 2023 March coupon on its 2026s for failure to meet this target.

Ultimately, the size of the coupon step-up reflects a balance between the fear by issuers that they will miss their SPTs and increase their cost of funding and a demand by investors that a failure to meet SPTs will carry a significant enough penalty to make the SPTs meaningful. Added to the mix is a general concern by investors that SPTs aren’t always set at challenging enough levels. Viewed from that perspective, the increase in the size of coupon step-ups may reflect a growing realization that investors will want an issuer to put its money where its mouth is when it signals a commitment to sustainability. Similarly, while missing its SPT was no doubt a bad thing for Public Power Corporation, overall it probably was a good thing for the SLB market, demonstrating that at least some companies set their SPTs at challenging levels..

SPT Redemption Premium

The SPT redemption premium requires the issuer to pay an additional premium when the bonds are redeemed early and/or at maturity, if the redemption occurs after an SPT failure, or the SPT documentation is not delivered, with the SPT redemption premium taking a variety of forms (described in depth HERE). As highlighted above, fewer bonds in H1’23 included an SPT redemption premium compared with all 2022 SLBs and more than two-thirds in 2021. However, given the increased number of bonds that were “make-whole for life” in H1’23, we’re not sure that this represents a new trend.

Similar to 2022, all H1’23 SLBs with an SPT redemption premium required payment of the premium during the non-make whole call period, except for Nexans’ 2028s, where it is also payable during the make-whole period.

Only one SLB issued in H1’23 included an SPT redemption premium payable during the make-whole period. As flagged at the beginning of this year, the reason for the limited presence of this feature in SLBs is linked to the costs associated with the verification of SPTs. Typically SLBs require an issuer to meet specified SPTs once during the life of the bond, meaning the issuer will only deliver the SPT documentation once. Delivery is commonly set two years or later from the date the bonds are issued. When an SPT redemption premium applies during the make-whole period, SLBs would typically include specific SPTs for each fiscal year, requiring annual testing and SPT documentation, which can be costly. It is hoped that regulations like the Corporate Sustainability Reporting Directive, applicable from the 2024 financial year for reports published in 2025 onward, will ease the reporting cost burden on issuers.
   
E, S or G

Environmental KPIs continued to be most popular among H1’23 SLB issuers, likely because they are seen as the easiest to track and more impactful to tackle climate change issues. Nonetheless, H1’23 SLBs incorporated environmental, social and governance related targets for the first time since the issuance of the first European high-yield SLB in 2021.

We saw three positive developments in this first part of the year.

First, French mining group Eramet introduced a governance KPI for the first time in a European high-yield SLB. Under its 2028s, the coupon will increase by 0.25% per annum if it fails to meet its governance-related SPT, requiring 67% of the Eramet group suppliers and customers to have decarbonization targets consistent with the well-below 2 degree Celsius scenario of the Paris Agreement as calculated by the Corporate Value Chain (Scope 3) Standard by Dec. 31, 2025.

Second, following the successful placement of the first European high-yield SLB featuring social targets in 2021, Teva Pharmaceuticals came back to market in H1’23 with new 2029s/2031s, also incorporating social targets aiming to increase access to its portfolio of medicines on the WHO’s Model Lists of Essential Medicines in low and middle-income countries by Dec. 31, 2025.

Third, the Republic of Chile issued the first SLB with a gender-based SPT. While its 2034s also contain an SPT based on absolute GHG emissions, significantly in these notes they set a target of women occupying at least 40% of board seats at publicly traded companies by the end of 2031. Although an investment-grade sovereign bond, it sets an example that we hope will be imported into the European high-yield SLB market soon. After all, having significant female representation in senior management positions is easily verifiable and is a worthy goal for companies in all industries.

While the difficulties in measuring the actual impact of social and governance KPIs in terms of sustainability performance will likely continue to be a constraint in the KPI setting process, the appearance of governance KPIs and reappearance of social KPIs show a positive sign that SLB issuers are willing to find solutions to overcome these limits rather than simply exclude social and governance issues from their ESG strategy.
 

Environmental KPIs

As illustrated above, most SLB issuers continue to focus on meeting environmental targets in the ESG space, and reducing impact on climate change (principally through GHG CO2 emissions) remains the most common environmental KPI seen in SLBs. However, in 2021 and 2022, some issuers expanded into other environmental areas: Fabbrica Italiana Sintetici, Itelyum and Reno de Medici had targets to reduce their water and waste consumption, and Constellium, Pfleiderer and Verallia focused on their recycling strategies. In H1’23, SLBs issuers focused solely on climate change-related issues.
 

Number of KPIs

In establishing SLBs, issuers have so far included one to three KPIs/SPTs as triggers for a coupon step-up and/or SPT redemption premium. SLBs with two and three KPIs/SPTs are the preferred option among H1’23 SLB issuers, departing from what was seen in 2022, where one KPI/SPT was much more common, and closer to the market in 2021.

 

Impact of Significant Events on Sustainability Targets

Since the inception of high-yield SLBs in Europe in 2021, issuers have been aware that the SPTs set at issue can be impacted during the life of the bond by the occurrence of certain material events, such as acquisitions, disposals, investments, regulatory or policy changes, and improved means of accessing ESG data. Any such event could mean the KPIs and/or SPTs are no longer appropriate for the issuer’s business and/or the issuer will be unable to perform at the level anticipated on the issue date.

The treatment of the impact of acquisitions, regulatory or policy changes, or other similar significant events on issuer’s KPIs/SPTs has not been standardized as yet. Some bonds keep the KPIs/SPTs the same, but allow the issuer to exclude the impact of certain material events on them (“exclusion”), while other bonds allow for amendments to the KPIs and/or SPTs to incorporate the impact of those events into the issuer’s sustainability strategy and targets (“amendment”). In some instances, both provisions are present, allowing the issuer to choose how to treat a significant event.

By way of illustration, an exclusion provision could allow an SLB issuer to exclude the impact of an acquired company for purposes of measuring its GHG emission-based SPT at the time of testing. An amendment provision, by contrast, would allow the issuer to amend its GHG emission-based SPT to take into account the impact of the acquired company. In either case, when an exclusion or an amendment occurs, the oversight of an external verifier may be required.

Except for Teva Pharmaceuticals’ 2029s/2031s, all SLBs in H1’23 included express amendment provisions to facilitate an update of KPIs and/or SPTs on the occurrence of a significant event after the issue date, with more than half requiring the oversight of an external verifier. The H1’23 trend is similar to what was seen in 2022, suggesting that the market is moving toward the inclusion of amendment provisions as a standard feature in SLB documentation. This is in contrast to the trend in 2021, where express amendment provisions were included in less than half of SLBs.

More than half of H1’23 SLBs expressly allowed the issuer to exclude the impact of material events (such as acquisitions, disposals, regulation, etc.) when calculating its SPTs, meaning that, at the issuer’s choice, such targets could remain unchanged in its SLB. This continues the trend seen in 2022, but is the opposite of the trend in 2021.

We saw a slight decrease in H1’23 - to around 60% - in SLBs allowing the issuer to exclude certain events or actions, down from 67% in 2022 but significantly up compared to 26% in 2021. Significantly, none of the SLBs containing exclusion provisions in H1’23 required an external verifier to verify the exclusion, leaving the decision to exclude a significant event and the manner of its calculation in the issuer’s sole discretion.

As mentioned earlier this year, this continues to be an area for improvement and should be a concern for investors, as such exclusions could affect their entitlement to the coupon step-up and/or SPT redemption premium.

To date, most SLBs continue to be silent on what level of bondholder consent is required to amend KPIs and/or SPTs. However, where KPI/SPT changes have an impact on the financial compensation (coupon step-up or SPT redemption premium) relating to SPT failures, there is an argument that such a change should require bondholder consent and be considered a supermajority consent matter, as would normally be the case for changes to a bond’s financial terms.

We saw no provisions in H1’23, similar to the ones seen in 2021 and 2022 in Accor’s 2028s and Verallia’s 2031s/2028s stating that specific types of amendments to KPIs and/or SPTs will not require bondholder consent, if such changes will not have an adverse effect on their interests.

Equally, we saw no provisions in H1’23, similar to the one included in Vodafone Ziggo’s 2032s requiring the issuer to consult the bondholders before implementing such amendments, but only if their interests will be adversely affected. As flagged in May 2022, a consultation does not give the bondholders a positive right of approval, especially if there is a dispute as to whether such amendments are adverse to bondholders’ interests.
 
SPT Documentation: Sustainability Compliance Certificate and Assurance Letter

In order to evidence compliance with the issuer’s SPTs, SLBs require delivery of an officer’s certificate or other notification, along with an assurance letter from an external verifier that such SPTs have been achieved. In line with what was seen in 2021 and 2022, all H1’23 SLBs only require the issuer to test compliance with its SPTs once during the life of the bond, meaning such issuers only deliver one compliance certificate/notification and assurance letter.

Delivery of the SPT documentation continues not to be a reporting obligation under all H1’23 SLBs. The issuer’s failure to deliver a compliance certificate/notification and assurance letter will not result in an event of default, but instead triggers the coupon step-up and/or SPT redemption premium (as applicable).

Sustainability Reports

Annual sustainability reporting continues to be an area of focus, highlighted in the sustainability-linked bond principles and emphasized by regulators and other governmental bodies. Accordingly, we continue to see an increasing number of SLBs requiring the delivery of sustainability reports, in particular on an annual basis.

Except for Teva Pharmaceuticals’ 2029s/2031s, all SLBs in H1’23 required the delivery of sustainability reports, with Eramet’s 2028s and Nexans’ 2028s providing for delivery of sustainability reports on an annual basis. The trend is similar to what was seen in 2022, suggesting that the market is moving toward the requirement for issuers to deliver sustainability reports, with the majority of H1’23 SLB issuers providing them on an annual basis.

When a sustainability report is provided, whether annually or at the time of testing, this could come either on a standalone basis or attached to the Sustainability Compliance Certificate. However, as with other SPT documentation, the failure to deliver a sustainability report does not trigger a default under the bonds.

Similar to 2022, in H1’23 we have not seen any SLBs requiring the delivery of independent third-party sustainability reports, with the reports instead being prepared by the issuer. However, all H1’23 SLBs required the named external verifier to provide statements of verification or assurance as to the issuer’s determination of SPTs (either in the company certificate/sustainability report delivered by the company or in a separate accompanying document), with Eramet’s 2028s and Nexans’ 2028s also requiring for the KPI level for each year to be verified by the external verifier.
 

The consistently increasing number of SLBs delivering a sustainability report is a positive development and hopefully represents the start of a new trend in the European high-yield bond market. However, the limited number of deals combined with the presence of repeat SLB issuers, like Teva Pharmaceuticals, could also have distorted the data as the tendency for the latter is to propose the same terms as in their existing bonds, which were issued at the inception of SLBs when sustainability provisions were not as developed as today. The introduction of the IFRS S1 and IFRS S2 standards (discussed below), combined with the EU regulations, including the Corporate Sustainability Reporting Directive will likely have a significant impact in this area.
 
The integrity of the ESG market continues to be a critical topic, with regulators and other technical bodies joining forces to create a better framework for greater transparency, standardization and comparability of ESG data, guidance and regulatory requirements to help develop the sustainability-linked market and increase its credibility. In order to give investors and stakeholders a comprehensive view of a company’s performance and commitment to driving sustainable value creation, consistency and comparability of sustainability information, paired with financial information, are essential.

As a result, on June 26, the IFRS Foundation’s International Sustainability Standards Board, or ISSB, the body working on integrating sustainability standards into corporate reporting, issued its IFRS S1 and IFRS S2 standards.

These standards are intended to ensure that companies provide sustainability-related information alongside their financial statements. Specifically, IFRS S1 provides a set of disclosure requirements designed to enable companies to communicate to investors about the sustainability-related risks and opportunities that could reasonably be expected to affect their cash flows, access to finance or cost of capital over the short, medium and long term. IFRS S2, by contrast, sets out specific disclosures regarding climate-related physical risks, transition risks and opportunities, and is designed to be used with IFRS S1.

While IFRS S1 and IFRS S2 are effective from 2024, the first reports of companies disclosing under these standards will be issued from June 2025. In the meantime, while the ISSB has launched a consultation on its future priorities, which closes on Sept. 1, jurisdictions around the globe, including the EU, are encouraged to integrate the ISSB standards into their own regulatory frameworks.

Continuing the efforts to achieve the objectives under the European Green Deal (which include no net GHG emissions by 2050 and economic growth decoupled from resource use), a new package of measures was announced to build on and strengthen the foundations of the EU sustainable finance framework. Overall, the package adds new activities to the EU Taxonomy and proposes new rules for ESG rating providers to increase transparency, ensure access to sustainable financing and make the sustainable finance framework easier to use. Among these measures, the European Commission is proposing a regulation to improve the reliability and transparency of ESG rating activities to protect investors and ensure market integrity. Notably, ESG rating providers will be required to be authorized and supervised by the European Securities and Markets Authority.

Furthermore, to expand the breadth of its Sustainability-Linked Bond Principles, the International Capital Market Association, or ICMA, has updated the principles and related tools to adapt the language for sovereign issuers, as well as to include new metrics for sovereigns and social issues in the KPI registry. Sovereign issuers have started using these target-based sustainable finance instruments, with the Republic of Chile the first sovereign issuing one in March 2022.

In addition, transition finance - which is the financing of the transition to environment-friendly performance over time - has become topical, both for companies that have already started transitioning and for those operating in hard-to-abate industries that have yet to begin. The 2023 edition of ICMA’s Climate Transition Finance Handbook provides additional guidance for issuers seeking to utilize green bonds, sustainability bonds or SLBs toward the achievement of their climate transition strategy.

These developments show that market participants are working to overcome the limits present in the current SLB bond market. However, improved guidance is still needed to help the healthy development of the market and ensure its credibility. For investors, appropriate guidance, regulations and comparability tools can help with investment decision making, allowing for clearer labeling of their investments, and helping to minimize mis-selling risks. For issuers, increased clarity will aid their compliance with applicable regulations and help make them a more attractive credit for potential investors.
 
Assurance Letter: Letter from the external verifier attesting the achievement of the relevant SPTs.

Coupon Step-Up: Price adjustment applicable to the coupon in SLBs if there is an ESG trigger.

ESG Trigger: An event, which if occurred, will result in a coupon step-up and/or a SPT redemption premium. This will typically include a borrower missing its SPTs, failure to deliver the SL documentation/SPT documentation or an external verifier qualifying the SL documentation/SPT documentation.

External Verifier: A borrower- appointed qualified third party providing assurance on whether the SPTs have been met or, in the context of amendments related to the sustainability-linked provisions, reviewing the relevant amendments.

Key Performance Indicator or KPI: Type of performance measurement. They are critical (key) quantifiable indicators of progress toward an intended result. In the context of SLBs, KPIs set the benchmark to determine whether a borrower has achieved its SPTs or not.

Sustainability-Linked Bond or SLBs: Bond instrument in which the pricing adjustment is linked to the borrower's performance against its SPTs. Where the issuer fails to meet one or more of its SPTs or deliver the SPT documentation setting out the performance against its KPIs, along with an assurance letter, investors will be typically entitled to a coupon step-up and/or a SPT redemption premium.

Sustainability Performance Target or SPT: Measurable improvements in KPIs on which borrowers commit to a predefined timeline.

SPT Documentation: Required documentation for SLBs evidencing whether a borrower has achieved its SPTs. This documentation, typically delivered once during the life of the bond, comprises an officer’s certificate (sustainability report or other notification), accompanied by an assurance letter.

SPT Redemption Premium: Price adjustment applicable to the redemption premium in SLBs if there is an ESG trigger.