Exploring Sustainability-Linked Bonds: Insights from the OECD
To discuss SLBs' important role in financing sustainable development - especially within emerging markets - and the role of the the Organisation for Economic Co-operation and Development (OECD) in supporting the market, we sat down with Paul Horrocks, Head of the Private Finance for Sustainable Development Unit and Emma Raiteri, Policy Analyst at the OECD.
From your perspective, particularly in the context of developing countries, what key elements attract investors to SLBs?
Additionally, what are the biggest challenges investors face with regard to SLBs?
Paul Horrocks: SLBs can be attractive to investors for numerous reasons. A forthcoming OECD-LuxSE survey on investor incentives for green, social, sustainability and sustainability-linked (GSSS) bonds found that alignment with institutional investment strategy is a key determining factor driving investment decisions in these instruments.
The fact that SLBs are inherently linked to sustainability targets therefore makes it easy to place SLBs within a broader investment strategy. Especially if an SLB is tied to existing sustainability commitments like the Paris Agreement Nationally Determined Contributions (NDCs), this is a strong signal of credibility for investors and helps counter greenwashing risks. More broadly, as instruments which link scale, long-term duration and impact, SLBs are a powerful way to tap into deep pools of private capital and as such help bridge the USD 3.9 trillion UN Sustainable Development Goals (UN SDGs) financing gap.
Emma Raiteri: Another advantage of SLBs is their changing financial or structural characteristics. For investors, this is seen as an enforcement mechanism to hold issuers accountable for their sustainability commitments. SLBs can also drive financing towards areas like adaptation, biodiversity and social outcomes. These are harder to finance with use-of-proceeds instruments like green bonds, but are increasingly of interest to investors, and this fungibility is particularly relevant in developing country contexts, where pipelines of bankable and sizeable assets can be rare.
Despite these clear advantages, investors can also face challenges. The key performance indicators (KPIs) and sustainability performance targets (SPTs) to which SLBs are linked can risk being financially immaterial and insufficiently ambitious, especially as these are set by the issuers themselves. Since KPIs and SPTs are the backbone of a strong and credible SLB, this can in turn make investors shy away from these instruments.
At the same time, monitoring progress towards KPIs and SPTs rests on the quality and availability of data – which, especially in developing country contexts, can often be lacking. This, too, can make investors critical of the true impact that these instruments are having. Finally, the aforementioned OECD-LuxSE survey also finds investors to be sceptical of certain financial characteristics embedded in SLBs – relating, for example, to the use of step-ups in low-income country contexts (which risk putting additional burdens on issuers), or to the (too) small size of the coupon step up/down.
Paul Horrocks: At the OECD, our work focuses on the role that development actors can have in overcoming the barriers that issuers and investors alike face when entering the SLB market, particularly in developing countries.
What policy considerations should donors take into account to increase investor interest and appetite for public sector SLB issuances in developing countries?
Paul Horrocks: Donor support can be fundamental both in helping issuers enter the SLB space, and in increasing investor interest for and confidence in these instruments. The two go hand-in-hand. At the OECD, we identify five major policy areas of donor support for green, social, sustainability and sustainability-linked (GSSS) bonds in developing countries -issuance, investment, insurance, (market)-infrastructure, and impact. We refer to this as the “five Is” framework, and it is highly relevant in the context of SLBs.
Through blended finance instruments, donors can directly enable issuances in developing countries. First-loss anchor investments, for example, can be used to signal the credibility of an issuance and of its underlying KPIs/SPTs. Similarly, donors can extend guarantees to SLBs, therefore transferring a portion of the risk away from investors. Here, it is important to note that these types of donor support can be fundamental in demonstrating the viability of the market – but should be seen as transitory as investors increasingly gain confidence.
Emma Raiteri: Donors can also intervene in the impact dimension of SLBs. They can provide guidance to issuers in selecting KPIs which are relevant and material to the issuer, and then also help determine the level of ambition in the form of SPTs. This can, again, serve as a guarantee to investors of the ambitiousness and appropriateness of the KPIs and SPTs – thus increasing the overall credibility of the bond. The OECD-LuxSE survey on investor incentives also finds strong investor interest in donor support for issuers’ post-issuance disclosure and measurement of impact.
Indeed, a number of capacity building and technical assistance programmes target post-issuance reporting, which helps increase investors’ trust in the issuer and local market. More broadly, it also helps build a strong and transparent track record, which can in turn inform future investment decisions.
Paul Horrocks: It is important to note that SLBs, like GSS bonds, are not a one-size-fits-all solution for all types of issuers. Especially in developing country contexts, it is important to ensure that issuers can sustainably take on more debt before issuing. This must be the first consideration for any type of support. When SLBs are deemed appropriate and effective, then donor support can be fundamental. And the good news is that we are already seeing this – from donors, but also from other key stakeholders like LuxSE. For SLBs to live up to their potential, however, it is important for this support to be scaled, and for it to meet the needs of private investors. And all of this cannot be done without greater co-ordination and co-operation.
This interview builds on the recommendations of the OECD report on Sustainability-linked bonds: How to make them work in developing countries. It also presents initial findings of the forthcoming OECD-LuxSE survey on investor incentives for public sector GSSS bonds.
