ECB makes ‘exceptional exception’ for sustainability-linked bonds

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A decision by the European Central Bank (ECB) to deem sustainability-linked bonds (SLBs) eligible for its asset purchase programmes has been welcomed as an “exceptional exception” that should support the relatively new addition to the sustainable fixed income market.

On Wednesday, the ECB announced it would accept SLBs as collateral and that it could start buying them under its asset purchase programmes provided they comply with programme-specific eligibility criteria.

SLBs are bonds with coupons linked to sustainability performance targets and, in contrast with use-of-proceed bonds such as green bonds, raise money for general corporate purposes rather than for defined projects or categories of activity.

Italian utility Enel was the first to issue such a bond last year, and in recent weeks issuance resumed with deals from companies such as Suzano, Chanel and Novartis.

Although green bonds have featured in the ECB’s asset purchase programmes for years, SLBs had not been eligible for them because the central bank considered coupon increases or decreases triggered by an issuer’s sustainability performance as a margin.

The ECB’s rules state that margins related to floating-rate coupon structures may only change over time according to a predefined path at issuance. With an issuer’s sustainability profile “a priori uncertain”, sustainability-linked bonds fell foul of these criteria.

The ECB’s decision concerning SLBs is effective 1 January 2021. According to a document published today, the ECB is adding a definition of the concept of a “sustainability performance target” to its guideline on the implementation of monetary policy in the euro-zone.

‘Opening up on environmental criteria’

Announcing the change, the ECB said the coupons on sustainability-linked bonds must be linked to a performance target referring to one or more of the environmental objectives set out in the EU taxonomy regulation and/or one or more of the UN Sustainable Development Goals (SDGs) relating to climate change or environmental degradation.

“This further broadens the universe of Eurosystem-eligible marketable assets and signals the Eurosystem’s support for innovation in the area of sustainable finance,” it said.

Ulf Erlandsson, a former portfolio manager at AP4 and now founder and executive chair of the Anthropocene Fixed Income Institute, said it was good news to see the ECB “explicitly opening up for such bonds on environmental criteria”.

“I also note that the ECB allows a broad spectrum of environmental criteria, more than only the EU taxonomy ones,” he added.

“This instrument could play an important role in supporting the ECB’s green ambition so it was a bit counterintuitive that the ECB couldn’t buy these instruments”

APG

Large pension investors in the Netherlands backed the inaugural SLB issuance from Enel, and a spokesman at APG told IPE it welcomed the ECB’s decision.

“This instrument could play an important role in supporting the ECB’s green ambition so it was a bit counterintuitive that the ECB couldn’t buy these instruments,” he said. ”By removing this hurdle we believe we can see a further growth of sustainability-linked bonds, a development we would welcome and support.”

Mitch Reznick, head of sustainable fixed income for Federated Hermes’ international business, is a supporter of SLBs, and said the ECB’s decision “sends a very strong signal acknowledging its important role in addressing the climate crisis”.

He said the ECB had made an “exceptional exception” that would support the further growth of the nascent market in sustainability-linked bonds.

In his view, the ECB’s decision showed that “its unqualified support goes beyond the EU taxonomy, the SDGs and sustainable finance in general,” he added.

“Above all, it, like us at Federated Hermes, believes that to address the climate crisis, companies can and must decarbonise their own processes of creating economic value. This can only happen at the company level; not just at the green-financed project level.”

The ECB’s decision comes after the International Capital Market Association (ICMA), the body behind the frameworks for green, social and sustainability bonds, in June set out best practice principles for SLB issuance.

Not everyone thinks SLBs are a necessary innovation.

At the time of the launch of the ICMA principles, Bram Bos, lead portfolio manager, green bonds at NN Investment Partners, said the asset manager welcomed them “as they will likely encourage companies to contribute to a more sustainable future” but said that the asset manager believed that green bonds were “a more powerful instrument than SLBs in achieving this”.