Sustainability-linked bonds could be more effective in driving the energy transition than "use of proceeds" instruments such as green bonds due to their ability to impact companies’ cost of capital, a leading ESG finance academic said.
However, SLBs, which tie pricing to the achievement of ESG targets, need more work to ensure which KPIs and incentive structures drive real change for different issuers, sectors and geographies to avoid greenwashing allegations, according to Ben Caldecott, director of the Oxford Sustainable Finance Group at Oxford University.
“SLBs could be one of the most effective instruments for driving change but at the moment there’s an awful lot of greenwashing and confusion,” Caldecott said, speaking at the inaugural two-day Oxford Sustainable Finance Summit.
“If SLBs are designed well, they can be genuinely transformative; green bonds are not in that category,”
Caldecott is also the founder of a new sustainable finance lab that is being created to accelerate action across the financial system to achieve net zero goals, strengthen climate action and introduce biodiversity targets.
ESG-labelled debt issuance has generally slowed this year in line with a broader market deceleration after Russia's invasion of Ukraine, but SLB issuance has held steady with a 6.4% increase in the first half of the year. US$43bn of SLBs were issued in the first six months of 2022, compared with US$40.3bn a year earlier, according to Refinitiv data.
SLB issuance is expected to pick up as the market stabilises. Caldecott sees the use of transition plans as critical to maintain the credibility of the SLB product and that KPIs need to be tightened and tested to ensure that they are achieving results.
“At the moment, we have a lot of sustainability-linked issuance where you have all these KPIs and the empirical work hasn’t been done to really understand if they reduce risk and improve environmental outcomes, which is the whole point of the structure,” he said.
Caldecott also believes that the effects of multiple KPIs need to be better understood to allow greater variation in deal pricing. In addition, this should vary the costs of capital for companies that are issuing SLBs and sustainability-linked loans, which can have three to five KPIs.
“There’s been very little work, if any, on understanding the positive and negative feedback loops associated with having all these different KPIs together – do they interact positively with each other, do they undermine each other, or do they just confuse everyone?” Caldecott said.
These two questions will be among the research undertaken by the new Oxford Sustainable Finance Lab, which will open in autumn 2022 with the UK’s Financial Conduct Authority as a founding partner.
The regulator’s ESG division will join the lab, which will be part of Oxford University’s Smith School of Enterprise and the Environment. It will allow researchers to collaborate with financial services professionals, supervisors, central banks, regulators, governments and civil society organisations.
The creation of the lab follows a £1.2m pledge by Bank of America in May to support research that will integrate nature-based metrics into sustainable finance frameworks and also work on carbon capture research at the Smith School.