by Shawn Keegan, AllianceBernstein
Environmentally minded investors, take note: we think a controversial new bond format that links a companyās sustainability goals to its bottom line could be a game changer in building a more sustainable futureāand a welcome complement to ālabeledā green bonds, which are project-specific.
The new format is exciting because it does two things. First, it puts the focus on a companyās sustainability goals. Second, it ensures that the company has skin in the game by penalizing it if it fails to meet those goals, which are explicitly written into the bond documentation.
Italian utility Enel, a major issuer of more traditional green bonds in the past, recently embraced this new approach when it issued a bond that pins the companyās renewable energy goals to its bottom line. If Enel falls short of having 55% of its electricity generation capacity in clean energy by the end of 2021āup from 46%āthe bondās coupon rises by 0.25%.
Rewarding Sustainability
The way we see it, thereās a lot to like here. Yes, itās true that funds raised from bonds structured in this way are directed toward a companyās general operating expenses rather than a specific project, as is the case with green bonds. But buying a general-purpose bond is appealing because the bond is structured so that it effectively rewards companies for having a sustainable business model.
Enelās goals are based on some of the United Nationsā Sustainable Development Goals (SDGs), such as providing access to affordable and sustainable energy and taking urgent action to combat climate change and its effects. Weāve written before that the SDGs provide a good road map for investors who want their investments to have an impact.
Overall, we consider this new structure a positive development and hope to see more issuesāand innovationsālike it.
Where Do Green Bonds Fit In?
Not everyone agrees, though. Some worry that replacing green bonds with goal-linked deals will weaken accountability.
For instance, the terms of these new deals allow companies to spend the proceeds however they wish. A utility company might opt to spend some on coal-powered electricity generation even as it works toward achieving its sustainability goals. Labeled green bonds, in contrast, have a specific green use of proceeds.
Hereās the thing: we donāt look at this issue as an either/or proposition. Green bonds have been a great way for companies and investors to advance environmental goals, as have blue bonds, which are used to finance sustainable marine-based projects and protect the worldās oceans. Indeed, funding specific projects makes a lot of sense and contributes to overall environmental sustainability.
But until now, there hasnāt been a way to hold a company accountable for moving in the right direction when it comes to environmental sustainability. This new format changes that. The more companies design and issue bonds this way, the more likely they are to meet environmental, social and governance (ESG) standards, since doing so is aligned with their bottom line.
Enel has said it intends to stop issuing green bonds and focus only on this new goal-based approach. But thereās no reason why other issuers couldnāt choose to do both, as needed.
Moving Beyond Labels
We think labeling will become less important as more companies embrace structures that link achieving green targets with the companyās own financial health. Just as important, we think investing in issuers that are financially committing themselves to sustainability is likely to increase progress on combating climate change.
As we wrote earlier this year, itās worthwhile to support automakers that have made commitments to building out their electric vehicle linesāeven if these companies still rely heavily on sales of fuel-inefficient trucks and SUVs. By lending to them, investors can still help to advance the transition to electric vehicles and the reduction of greenhouse gas emissions.
Itās clear that sustainability is becoming a consideration for companies todayāand for many bond investors. But thereās room for improvement. In our view, bond structures that use an integrated, goal-based approach can help encourage companies to participate in building a greener world.
Shawn Keegan is Portfolio ManagerāCredit at AB.
The views expressed herein do not constitute research, investment advice or trade recommendations, do not necessarily represent the views of all AB portfolio-management teams and are subject to revision over time.
This post was first published at the official blog of AllianceBernstein..