Thu 01/26/2023 06:05 AM
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Key Takeaways


  • Sustainability-linked issuances in 2022 remained at consistent levels to 2021. This is notable as it shows that the incredible uptick in issuance of sustainability-linked bonds in 2021 continued in 2022 despite the dramatic drop in European high-yield issuance last year amid multiple adverse economic and geopolitical factors.

  • A study of Reorg’s proprietary ESG data shows that sustainability-linked provisions in high-yield have now reached a certain level of standardization.

  • A key area where standardization is building is pricing adjustments. The overwhelming majority of 2022 sustainability-linked bonds applied a modest 0.125% increase to the coupon for each sustainability target not met.

  • There was still room for innovation. In 2022, for the first time in a sustainability-linked bond, Vodafone Ziggo included an economic incentive if the group met its sustainability targets. Unlike European sustainability-linked loans where two-way margin adjustments are common, typically in sustainability-linked bonds a company is penalized if it fails to meet its sustainability targets but not rewarded if it does meet them.

  • Positively in 2022, European sustainability-linked bonds have provided investors with more clarity on how certain events may impact the sustainability-linked pricing adjustments and with access to better ESG disclosure from issuers.

  • In 2022, the focus was on the “E” of ESG, with sustainability-linked bond issuers ignoring social and governance issues.


Many predicted European sustainability-linked bonds (“SLBs”) with environmental, social and governance (“ESG”) features would increase their overall share of the European high-yield market in 2022, riding on the coattails of 2021. While this anticipated increase did not materialize in 2022, SLB issuance last year kept a similar overall pace to 2021, featuring in 15% of European high-yield bonds compared to 16% in 2021, notwithstanding the substantially lower volume of European high-yield issuance in 2022.

Sustainability-linked provisions in high-yield have now reached a certain level of standardization, shaping the direction in which European ESG financing is developing. In particular, ESG related pricing mechanisms and adjustments appear to be increasingly consistent since our first review of European SLBs last year.

Positively, European SLB documents in 2022 have provided investors with more clarity on how certain events may impact the sustainability-linked pricing adjustments and with access to better ESG disclosure from issuers.

However, there is still room for improvement. The lack of commitment from SLB issuers with respect to social and governmental issues continued in 2022 with SLB issuers only focused on tackling environmental issues. In 2023, we hope to see SLB issuers expand the scope of their key performance indicators (“KPIs”) and sustainability performance targets (“SPTs”) to social and governmental issues. In addition, ESG data, methodologies, consultant review and external verification continue to show their limits. More transparency and regulation is needed to help ensure a correct flow of information and combat greenwashing.

Looking ahead, we expect European high-yield bond issuances to be lower in 2023 compared to the stellar levels of 2021, as inflation and interest rates continue to rise. However, the steady presence of sustainability-linked bonds in the European high-yield bonds market in 2022 highlights the resilience of, and shows promise for the growth of ESG in high-yield in 2023.

SLB issuances in 2023 are expected to come from issuers in a wider range of sectors due to investor demand, changing regulations and a desire to align financing needs with sustainability objectives. We also expect 2025 to be a key year for SLBs, because the majority of 2021/2022 SLBs issuers have set their deadlines to achieve their SPTs by this year.

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, 2022 to Dec. 31, 2022 (“2022 SLBs”). From time to time in this article we compare 2022 SLBs with SLBs reviewed from Jan. 1, 2021 to Dec. 31, 2021 (“2021 SLBs”).

A note of caution: Given the lighter volume of deals in 2022, the statistics for 2022 SLBs are more sensitive to distortion. In most instances, the statistics suggest some identifiable trend, but in a few instances showed movements that could be explained as much by the market as by data distortion.
Market, Regulation and Best Practices Overview

The scope of sustainable finance regulation has grown exponentially in 2022. The outbreak of the Russian-Ukrainian war with its impact on energy prices has created even more economic opportunities for investing in alternative energy solutions (e.g. hydrogen). However, ESG investigations last year raised concerns over potential weaknesses of the ESG market. Accordingly, regulatory bodies across the globe have joined forces to prioritize disclosure transparency and prevent greenwashing in order to help the development of sustainable finance.

The ESG investment process is mainly driven by available ESG data and ESG providers. However, the lack of clarity, especially from a regulatory perspective, in the ESG space on how ESG data should be collected and reported, what methodologies should apply when calculating and collecting data and, consequently, the subjectivity applied by ESG rating agencies when assessing SLB issuers seem to be an obstacle to the full development of sustainable finance. This emerged from the targeted consultation on ESG data and ratings carried out last year by the European Commission, where the vast majority of respondents seem to agree that some sort of change is necessary, with the large majority supporting a legislative intervention.

Regulatory bodies around the world have been busy tackling this issue while waiting for the finalization of a global baseline of reporting standards by the IFRS Foundation’s International Sustainability Standards Board, which aims to integrate sustainability standards into corporate reporting.

Some regulatory bodies encouraged application of industry standards. This is the approach adopted by the UK Financial Conduct Authority while waiting for the U.K. Government to bring ESG data and rating providers within its regulatory perimeter. To ensure trust in ESG-labeled debt instruments, the FCA encouraged issuers to voluntarily adopt and apply the relevant industry standards such as ICMA’s Principles and Guidelines.

European institutions have continued working extensively on implementing sustainable finance on different fronts. The Corporate Sustainability Reporting Directive will ensure better access to information for market participants assessing investment risks arising from climate change and other sustainability issues. The directive will apply from the 2024 financial year, for reports published in 2025 onwards. Listed small and medium enterprises will also now be required to report on sustainability, but they will be exempted from the application of the directive until 2028.

Most recently, the European Supervisory Authorities (EBA, EIOPA and ESMA – “ESAs”) published a call for evidence on greenwashing to gather input from stakeholders on how to understand key features, drivers and risks associated with greenwashing and to collect examples of potential greenwashing practices. This follows a request for input by the European Commission in relation to greenwashing risks and supervision of sustainable finance policies, which follows up on its Renewed Action Plan.

Across the Atlantic, eyes are on the next developments to the climate disclosure requirements proposed by the Securities and Exchange Commission last March. Also aiming to facilitate access to climate related information, the SEC rule has not been finalized yet but companies are already pointing out the high costs that it will bring.

More developed and improved guidance such as those published by ICMA, FCA, and the advent of new regulations, could help ESG financing by giving it more credibility and clarity. On the investor side, appropriate guidance and regulations can help with investment decision making, allowing for clearer labeling of their investments, and 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.
An Overview of Sustainability-Linked Bonds

SLBs include provisions setting out one or more KPIs and SPTs that the issuer has identified and aims to achieve during the life of the bonds. Where the issuer fails to meet one or more of those targets or deliver an officer’s certificate (sustainability report or other notification) (“SPT Documentation”) setting out the performance against its KPIs, along with an assurance letter from an issuer-appointed qualified third-party (“External Verifier”), investors will be typically entitled to an increase in the coupon by a specified percentage (“Coupon Step-Up”) and/or a redemption premium (“SPT Redemption Premium”).

After appearing in 2019 for the first time with Italian energy group Enel issuing a $1.5 billion 2.650% due 2024, SLB issuances took off in 2021.

SLBs made up 15% of 2022 European high-yield bonds compared to 16% in 2021.

As illustrated in the graph below, SLBs came to the market in force in Q1 2022 compared to the tentative SLBs issuances in Q1 2021, before the disruption of the primary markets due to the war in Ukraine. There were no SLB issuances in Q2 and Q3, with the SLB market picking up again in Q4 2022.

In 2022, most SLBs were issued by companies in manufacturing and industrial sectors. The paperboard and packaging, manufacturing, retail and chemicals sectors accounted for the majority of SLB issued in 2022, similar to what was seen in 2021.

While in 2021 we saw SLB issuances touching upon a wider number of less environmentally impacted sectors (at least in terms of greenhouse gas emissions), 2022 saw much less variety. But positively, SLBs expanded to the telecommunication sector, with Dutch telecom company Vodafone Ziggo issuing its first SLB in January 2022.

Trends and Innovation in Sustainability-Linked Pricing Adjustments

Step-Up Triggers and Pricing Adjustments

2022 saw innovation in the sustainability-linked pricing adjustments in European high-yield bonds.

In 2021, all SLBs included a step-up trigger, which meant that the coupon and/or redemption premium would increase if the issuer missed one or more of its SPTs or failed to deliver the SPT Documentation. We saw a new development in 2022. In Vodafone Ziggo’s 2032s a step-up (and down, as discussed below) will kick in if the External Verifier that verifies Vodafone Ziggo’s achievement of its SPTs is unable to verify the same or qualifies its assurance letter. While the new wording represents only a marginal tightening of the requirements in the step-up triggers seen so far in SLBs, it shows the continued efforts of the market to encourage full disclosure and cooperation between issuers and their report providers, addressing investors’ increased focus on greenwashing concerns.

In 2022, Vodafone Ziggo’s 2032s stood out in terms of innovation by being the first European high-yield bond applying a two-way mechanism to the notes’ redemption price. Under the terms of the notes, the redemption price increases by 0.125% if the group does not meet both of its SPTs (as is typical), but (this is new) also decreases by the same percentage if both (not just one) of its SPTs are met. While two-way pricing adjustments are common in sustainability linked-loans, operating through the margin ratchet, they hadn’t previously been used in bonds, which do not have a margin ratchet provision. All other 2022 SLBs only applied a one-way pricing reduction, which remains the market standard for European SLBs.

In 2022, there were no SLBs with only a Coupon Step-Up. This is 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 as the issuer may be able to redeem its bonds at par. In most cases, if there is also a SPT Redemption Premium upon an SPT failure the SPT Redemption Premium will be payable at the time of redemption.

In order to ensure there is an effective pricing adjustment, almost two-thirds of 2022 SLBs included both a Coupon Step-Up and SPT Redemption Premium payable for an SPT failure, similar to 2021.

Pricing Increase Amounts

Coupon Step-Ups

The size of the Coupon Step-Up varied widely in 2021, ranging from +0.1% (Verallia’s 2030s/2031s) to +0.75% (Graanul’s 2026s) for each SPT not met - with more than half of 2021 SLBs applying a +0.125% step-up. The 2021 majority position entrenched itself in 2022. All 2022 SLBs with Coupon Step-Ups, except for Forvia’s 2026s, applied a +0.125% step-up for each SPT, suggesting the market is moving towards a standardized step-up increase. Forvia’s 2026s applied a 0.25% step-up, which was the second most common price increase in 2021.

SPT Redemption Premium

Some SLBs require payment of an additional premium when the bonds are redeemed early and/or at maturity, if redemption occurs after an SPT failure or the SPT compliance notice is not delivered. SPT Redemption Premiums can take different forms, which we have described in depth HERE.

The vast majority of 2022 SLBs with an SPT Redemption Premium required payment of the redemption premium during the call period, except for Webuild’s 2026s, where it is payable at maturity, and Fabbrica Italiana Sintetici’s 2027s, where it is also payable during the make-whole period.

Although slightly lower compared to 2021, SLBs with an SPT Redemption Premium payable during the make-whole period continue to be a small minority and a departure from the market standard. The reason can be linked to the costs associated with the SPTs verification requirements. 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 will ease the reporting cost burden on issuers.

Sustainability KPIs

E, S or G

The International Capital Market Association (“ICMA”) has recently categorized approximately 300 KPIs for SLBs and grouped them within the three sustainability themes (Environmental, Social or Governance or E, S, or G) in its effort to standardize their classification. In this article we have used the ICMA categorization.

In 2022 SLB issuers focused solely on tackling environmental issues, mainly by including climate change related KPIs and SPTs. While last year we thought there was scope for issuers to deepen their commitment to S and G principles and follow the example of Teva Pharmaceuticals, which issued SLBs with social targets, no SLBs issuers in 2022 adopted a social or governance cause. This is probably because environmental KPIs are seen as the easiest to track and more effective as they could potentially have a global impact.

Number of KPIs

Regardless of whether the focus is on environmental, social and/or governance matters, there is no definite trend in the number of KPIs and SPTs that European high-yield companies seek to meet in their sustainability program. The number varies from one to three.

In 2022, the majority of SLB issuers preferred to set only one KPI, diverging from the trend seen in 2021 when two KPIs was the most popular approach.

Impact of Significant Events on Sustainability Targets

The assumptions upon which SPTs are set at issue can change during the life of the bond, including when significant events occur such as material acquisitions, disposals, investments, regulatory or policy changes (called an “event” in this section). Any such event could mean the KPIs and/or SPTs are no longer appropriate for the issuer’s business and/or the issuer is unable to perform at the level anticipated on the issue date.

When we first wrote about SLBs, we flagged that there was no consistency in the treatment of the impact of acquisitions, regulatory or policy changes, or other similar significant events on issuers’ KPIs/SPTs. While some bonds allow the issuer to exclude the impact of certain events, others allow for amendments to the KPIs and/or SPTs to incorporate the impact of those events into the issuer’s sustainability strategy and targets.

Nearly three-quarters of 2021 SLBs did not have a specific provision allowing the issuer to exclude corporate actions when determining SPT achievement. 2022 shows an opposite trend. In 2022, more than two-thirds of SLBs allow the issuer to exclude certain events or actions. The significant rise of exclusion provisions in 2022 SLBs is welcomed as it provides clarity to investors with respect to what events could impact the SPTs and, consequently, the sustainability-linked pricing adjustments.

Typically the application of the exclusion provision is determined, however, by the issuer alone with only a minority of these provisions requiring a certification from an External Verifier. This is an area for improvement and should be a wake-up call for investors as exclusions could affect the investors’ entitlement to the potential reward. In addition, by leaving these determinations exclusively in the issuer’s hands (without external controls or bondholders consent) litigation risks could arise as parties may disagree on the outcome, especially when economic or reputational interests come into play.

All 2022 SLBs include express provisions to amend KPIs and/or SPTs, with the vast majority requiring the oversight of an External Verifier. Such provisions give investors greater clarity as to how the expected pricing increase in the bonds may change if the KPIs/SPTs are amended (including upon the occurrence of a significant event).

To date, SLBs have been silent on whether consent of bondholders is required to amend KPIs and/or SPTs. But where such KPI/SPT changes have an impact on the financial compensation (Coupon Step-Up or SPT Redemption Premium) relating to SPT failures, there may be a question as to whether 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.
Disclosure, Reporting and External Verification

In order to evidence compliance with the issuer’s SPTs, SLBs require delivery of an officer’s certificate, sustainability report or other notification, along with an assurance letter from an External Verifier that the SPTs have been achieved, typically once during the life of the bond. Delivery of the SLB Documentation is not a reporting obligation and failure to deliver such documentation letter will not result in an event of default.

Except for Fabbrica Italiana Sintetici’s 2027s, which set SPTs for specific fiscal years and require annual testing and compliance notification, all 2022 SLBs only require the issuer to test compliance with its SPTs once during the life of the bond.

The sustainability-linked bond principles encourage issuers to publish, at least annually, a sustainability report providing up to date information on performance of their KPIs, how calculations have been made and any adjustments made to KPIs/SPTs. While many issuers do offer to provide such sustainability reports to investors, delivery of these reports is not required by the reporting covenant. As a result, failure to deliver the sustainability report will not be an event of default.

Overall, we have seen an uptick in the number of SLBs requiring delivery of a sustainability report. This requirement was contained in Novolex’ SSN 2029s, Novolex’s SNs 2030s, Fabbrica Italiana Sintetici’s 2027s, WeBuild’s 2026s and Vodafone Ziggo’s 2032s. Except for Novolex, all other issuers will provide their sustainability reports on an annual basis, a positive development in 2022 compared to 2021.

While the requirement for fully independent reports have not been seen in any of the 2022 SLBs, all 2022 SLBs require for 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).

The 2022 picture on sustainability reports is definitely a sign of improvement compared to 2021. One explanation could simply be the lower number of deals in 2022 distorting the data. However, this could also be explained by the increased investors’ focus on ESG disclosures to help combat greenwashing. However, we expect further developments in this area following publication of the updated Guidelines for Green, Social, Sustainability and Sustainability Linked Bonds External Reviews by ICMA, and of other guides by other technical bodies and regulators.
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