Companies Test a New Type of ESG Bond With Fewer Restrictions

Finance chiefs are selling a new type of bond designed to attract socially minded investors that costs less and offers more leeway for companies than other types of sustainable debt.

These instruments, known as sustainability-linked bonds, are similar to traditional debt sales—with one major exception: They are usually structured such that companies pay a higher interest rate to investors if they fail to achieve a set of environmental and other goals before the maturity date. Also, the proceeds from these bonds can be used for general purposes, such as paying down existing debt, which sets it apart from other types of green, social and sustainability bonds.

Luxury fashion brand Chanel, pharmaceutical company

Novartis AG

and Brazilian paper maker

Suzano SA

all issued sustainability-linked bonds in September, according to the Climate Bonds Initiative, a nonprofit that tracks such debt sales. Italian utility


SpA was the first company to issue this type of debt last fall.

The four companies together raised roughly $8 billion, according to Climate Bonds Initiative. There haven’t been any issuances by an American company.

This new type of debt is gaining popularity as companies take advantage of historically low interest rates to shore up cash as they weather the pandemic. Chief financial officers, whose job it is to review their company’s funding tools on a regular basis, are increasingly using new types of debt to demonstrate their social consciousness credentials to investors, and to attract new types of investors.

Corporate green-bond issuance has increased by about eightfold over the past five years, to $77.4 billion, according to data provider Dealogic. In comparison, investment-grade companies issued $2.3 trillion in traditional bonds through Oct. 1, a 9% increase compared with the whole year of 2019, Dealogic said.

Generally, proceeds from green bonds must be spent on a designated ESG project—such as construction of a renewable-energy facility—and companies have to track and report to investors how they spent the money. Before issuing a green bond, companies also adopt a formal ESG financing framework, which is reviewed by an external firm such an ESG ratings agency.

Sustainability-linked bonds appeal to companies that want to offer ESG bonds with fewer financial restrictions, executives said. Companies issuing sustainability-linked bonds expect lower staffing and administrative costs compared with other types of environmental, social or governance bonds.

More companies, including U.S. firms, are expected to sell these bonds in the coming months, said Heather Lang, an executive director of sustainable finance solutions at the ESG ratings firm Sustainalytics. That is in part due to new guidelines for this type of issuance by the International Capital Market Association, an industry organization, a move that provided additional credibility to companies issuing these bonds.

Novartis’s sustainability-linked bond sale in September totaling 1.85 billion euros—equivalent to $2.2 billion–was the company’s first trip into the ESG-bond market. The company set itself targets for increasing patients’ access to treatment for malaria and other illnesses in certain countries by 2025. If an external verifier determines that Novartis failed to meet those targets by the 2025 deadline, then the coupon rate on the bonds, which is set at zero, will increase to 0.25% for the following three annual coupon payments until the bond matures in September 2028, a spokesman said.

Novartis sold 1.85 billion euros, equivalent to $2.2 billion, in sustainability-linked debt last month.


sebastien bozon/Agence France-Presse/Getty Images

Investors are able to get more clarity on Novartis’s social commitments through such a bond sale, and the company doesn’t have to expend extra resources to isolate ESG projects, a company spokesman said.

“It is…not practical for us to separate out specific ESG projects from our so-called ‘regular’ business activities,” the spokesman said. “And if we could identify and monitor a discrete project, it wouldn’t be of a size to justify a multibillion-dollar bond issuance in the capital markets.”

Novartis said it plans to use the proceeds of the bond offering for general purposes, and didn’t provide any more details. The last time it issued in euros was two years ago, when it sold bonds with coupon rates ranging from 0.5% to 1.7%, according to Dealogic.

Enel switched from selling green bonds to sustainability-linked bonds last fall because of the financial benefits, including lower administrative costs, said Alberto De Paoli, the company’s CFO. Among those were lower staffing needs, fewer third-party assessments and less rigid rules on spending the money, Mr. De Paoli said.

Enel in September 2019 issued a five-year $1.5 billion sustainability-linked bond carrying a coupon rate of 2.65%, and a month later sold another 2.5 billion euros, equivalent to $2.9 billion, through the same type of debt offering. The proceeds are being used to fund sustainability efforts such as network digitization and renewable-energy projects, a spokeswoman said. As part of the offerings, Enel pledged to generate 55% of its installed energy capacity with renewable sources by the end of 2021 and cut its greenhouse-gas emissions. Its interest rates will go up by 25 basis points annually if it doesn’t meet its goals.

Mr. De Paoli said that the financial benefits of sustainability-linked bonds could push more companies to issue the debt—and set targets for improving the environment. “Not because they want to be sustainable and want to go to heaven, but because they are pursuing some economical reason,” he said.

Write to Kristin Broughton at [email protected]

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