Student Voices | Sustainable Bonds: Greenwashing Risk on Sustainability-linked Bonds
Responsible Business Center | Jul 18, 2024 | Gabelli School of Business
Institutions, governments, or corporations can issue four types of sustainable bonds: Green bonds, Social bonds, Sustainability Bonds, and Sustainability-linked Bonds (SLBs). This article assumes familiarity with these concepts among the investment community, and those seeking a refresher on the definitions and distinctions of each bond type can refer to this article.
The categorization of bonds into green, social, sustainability, or sustainability-linked is essentially connected to the use of proceeds the issuer will give to the capital raised from that debt instrument. However, while the proceeds raised from green and social bonds are specifically tied (i.e., “earmarked”) to new or existing projects with environmental and/or social benefits, the sustainability-linked bond is a “catch-all” bond category where the issuer does not contractually commit to using the proceeds obtained from investors specific green or social projects but rather provide funding for the overall operations of the issuer that has clear sustainability goals connected to the financial terms of the bond, even though that issuer will still benefit from lower interest rates typical of that debt instrument.
This article will delve into why SLBs, among all types of sustainable bonds, have the highest risk for greenwashing and lead to potential misallocation of funds and investor skepticism.
SLBs “are any type of bond instrument for which the financial and/or structural characteristics can vary depending on whether the issuer achieves predefined Sustainability/ESG objectives.” Greenwashing refers to the practice where companies or organizations misrepresent the environmental benefits of their actions or products to appear more environmentally friendly than they truly are*. This approach can mislead stakeholders, including consumers, investors, and regulators, into believing that a company’s products, aims, or policies are environmentally responsible when this may not be the case.
In the sustainable bonds space, greenwashing can happen as a result of broad and loose criterias for what constitutes a green, social or sustainable bond with the lack of a market standard or formal issuance guideline serving as a key factor in that respect. If no formal rules exist with respect to the definition of a sustainable bond, that market lacks integrity, and investors and market participants can’t compare apples to apples, leaving issuers with wiggle room to label and represent what they consider “sustainable”. Therefore, greenwashing can undermine genuine efforts towards sustainability, as it diverts trust and capital away from projects and products that offer real environmental benefits. There are clear rules to define what a SLB is pursuant to the Sustainability-linked Bond Principles set by ICMA; however, the challenge lies in the use of proceeds arising from the capital raised with the bond issuance.
For some, the existence of SLBs fills the gap for a debt mechanism to encourage the transition from a brown to a green economy. In this perspective, the instrument’s forward-looking optics, attached to specific KPIs, are credible signals of the issuer’s sustainability commitments**. These KPIs are generally connected to transition measurable metrics such as reduction in greenhouse gas (GHG) emissions, energy savings, improvement in ESG ratings, or other similar indicators. However, there is a problem with relying on the effectiveness of such instruments when aligning metrics without tangible projects or results. It opens the possibility of numerical manipulation and dubious storytelling, when analyzing metrics from different angles, and often does not offer real environmental change. It is common to see KPIs not material enough to provide effective change, and targets are often not far from business-as-usual practices.
According to Bloomberg, global SLBs issuance reached $67.75 billion in 2023, representing – not surprisingly – a 22% drop relative to 2022, given questions regarding the credibility of sustainability targets and greenwashing risks. Another Bloomberg article recently reported that over 80% of the 768 sustainability-linked bonds issued between 2018 and November of the previous year do not align with global climate goals.
Because of such problems, SBLs are seeing an increased backlash, evidenced in reduced issuance volume in the past year. The significance, rigor, and ambition of the KPIs used to gauge the impact of SLBs are material factors in their effectiveness. These KPIs must be bold and realistically match with the issuer’s long-term sustainability strategies, like cutting greenhouse gas emissions or increasing the capacity for renewable energy, in order for SLBs to actually incentivize the issuer to achieve their Net Zero goals. Therefore, transparency in reporting and clear, impactful KPIs are critical to ensure that SLBs contribute effectively to the global transition to a low-carbon, sustainable economy instead of being a source of cheaper cost of funds with no attached real impact.
* Laufer, W. S. (2003). Social Accountability and Corporate Greenwashing. Journal of Business Ethics, 43(3), 253-261.
** Beat Affolter, Elisa Ciarla, Julia Meyer, Sugandhita Sugandhita. Signaling sustainability: Differential reaction of the stock market following the announcement of sustainability-linked bonds, Finance Research Letters, Volume 63, 2024.
Written by: Luis Pinto, MBA 2024 and Walder Almeida, MBA 2024
