FINANCE & SUSTAINABILITY
Sustainability-Linked Debt Financing
Sustainability-linked bonds are a form of fixed-income financing that is gaining in popularity. In fact, according to Bloomberg, U.S. loans focused on ESG outcomes increased $52 billion in just six months in 2021, a 292% increase compared with all of 2020.
Sustainability-linked loans and bonds have joined the suite of sustainability-focused debt instruments like green bonds, social bonds and microfinance. Let’s look at the differences between these sources of debt financing.
Four Main Types of Sustainable Debt Financing
It is important to differentiate between debt instruments tied to use of proceeds and those who, as Environmental Finance explains, tie the coupon rate to the fulfillment of overall Key Performance Indicators (KPIs):Â fulfilling the sustainability goals can earn a discount, failing to do so a premium. Use of proceeds instruments include green and social bonds. Sustainability-linked loans and bonds, seen by investors as more flexible, are linked to overall corporate KPIs.
Green Bonds
To qualify as a “green bond” the proceeds must be used to fund projects with positive environmental outcomes. Examples include climate bonds, blue bonds, clean transportation, and wasterwater management.
Example: Verizon Wireless
Social Bonds
To qualify as a “social bond”, proceeds must be used to achieve positive social and economic outcomes for an identified target population. Examples include social bonds to fund affordable housing, food security, and access to essential services.
Example: Citigroup
Sustainability-linked Loans
Sustainability-linked loans provide funds for corporate level work (instead of project level) with interest rates that are linked to the borrower’s ability to hit defined performance targets.
Example: Anheuser-Busch Inbev
Sustainability-linked Bonds
Sustainability-linked bonds provide funds for a particular project or initiative that is committed to advancing sustainability and the coupon is tied to the corporation’s achievement of pre-defined sustainability-focused KPIs.
Example: Enel
Microfinance: Capital Access for the Unbanked
Microfinance is a topic that is related to sustainability-linked bonds/loans, but instead of lowering the cost of capital, microfinance makes capital available to low-income individuals.
Low-income individuals are typically not eligible for financial services because they are considered either inaccessible or uneconomical. See “What does it mean to be unbanked” from IAmUnbanked.org at right.
According to FINCA, Microfinance microfinance can present a solution to this problem by offering credit to these marginalized groups in the form of small working capital loans.
Microfinance was popularized by Muhammad Yunus, founder of Grameen Bank. It has grown in popularity with billions annually being made available to individuals and families who hadn’t previously been able to access capital. However, it is not without its detractors who have identified how microfinance can be misused and result in the poor facing more debt and unreasonable payment terms.
Still, microfinance is another tool in the toolbox of today’s financial professional along with the debt instruments presented above. With all financial instruments, since they deal with money, have the possibility of abuse and mismanagement. If we can guard against misuse, these new approaches to debt financing hold great promise.
Learn about more sustainability concepts within this major.
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