Sustainability-Linked Bonds Will Be Eligible As European Central Bank Collateral

In our recent Update Sustainability-Linked Bonds — A New Feature of the Sustainable Finance Landscape (June 2020), we set out our thoughts on some of the advantages and disadvantages of using SLBs as a means of raising finance.

The International Capital Market Association (ICMA) Sustainability-Linked Bonds Principles (SLBPs) define SLBs to mean “any type of bond instrument for which the financial and/or structural characteristics can vary depending on whether the issuer achieves predefined sustainability/environmental social or governance (ESG) objectives.”

To date, the few SLBs that have been issued¹ have been structured to include coupon step-up provisions that are triggered when the defined performance targets are not met. As mentioned in our June Update, such instruments have, so far, not been eligible assets for the various asset purchase programs operated by the ECB, a factor that, in our view, has presented perhaps the greatest obstacle to the use of SLBs as a mean of raising finance by Eurozone issuers.²

That has now changed. In a welcome development with potentially significant ramifications for the SLB market, the ECB announced on September 22 that, starting January 1, 2021, SLBs will be eligible as central bank collateral and also potentially eligible as assets for the purposes of its Asset Purchase Programmes and the Pandemic Emergency Purchase Programme, subject to compliance with program-specific eligibility criteria.

For SLBs to be eligible as collateral, the ECB will require coupons to be linked to a performance target referring to one or more of the environmental objectives set out in Regulation (EU) 2020/852 (the EU Taxonomy Regulation)³ and/or to one or more of the United Nation’s Sustainable Development Goals relating to climate change or environmental degradation.⁴

There are many institutions that are closely monitoring developments in the ESG sector with a view to capitalizing on their overall green and social corporate strategies but lack sufficient current green or social assets to justify issuing a green or social bond.⁵ SLBs are expected to be a useful means for such issuers to market their overall sustainable corporate strategies while accessing funding from a diversified market. By removing what was arguably the single biggest obstacle to the development of the market, the ECB has demonstrated its clear support for the product, and this could result in a significant increase in the number of SLB issuances in Europe.

Only SLBs that target goals that are linked to “green” KPIs satisfy the ECB’s criteria. While there is little doubt that this remains an important milestone in the market, we feel an opportunity has been missed to expand the use of such instruments to facilitate social improvements beyond the environmental. One might have expected that to be a point of focus, particularly in light of the growing momentum over recent months to use social bonds as a means of raising capital in the fight against the coronavirus in the current pandemic.

¹ Enel Finance International NV US$1.5 billion 2.650% SLB due September 10, 2024, unconditionally and irrevocably guaranteed by Enel S.p.A.
Enel Finance International NV €1 billion 0.000% SLB due June 17, 2024; €1 billion 0.375% SLB due June 17, 2027; and €500 million 1.125% SLB due October 17, 2034, each unconditionally and irrevocably guaranteed by Enel S.p.A. Suzano S.A. US$750 million 3.750% SLB due January 15, 2031 – this is the first bond to be issued under the ICMA SBLPs. Novartis Finance S.A., €1.85 billion fixed rate SLB due 2028 unconditionally and irrevocably guaranteed by Novartis AG – this is the first SLB linked to social rather than environmental performance.

² In line with our view, since the publication of the SLBPs in June 2020, the only other issuers that have issued a SLB, the Brazilian pulp and paper company Suzano and the Swiss pharmaceutical company Novartis, would not have been eligible for the ECB’s asset purchase programs, independent of the structure of their SLBs, because both companies are outside the Eurozone. Similarly, on September 24, 2020, Chanel (the French luxury brand) issued its SLB; again, that SLB would not have been ECB-eligible in any event because Chanel is an unrated company.

³ Per Article 9 of the EU Taxonomy Regulation, these are climate change mitigation, climate change adaptation, the sustainable use and protection of water and marine resources, the transition to a circular economy, pollution prevention and control, and the protection and restating of biodiversity and ecosystems. For more information about where the Taxonomy Regulation fits within the EU’s sustainable finance framework, please see our previous Update EU Advances ESG Related Reforms to Financial Services Regulations (June 2020).

⁴ The UN Development Goals are no poverty; zero hunger; good health and well-being; quality education; gender equality; clean water and sanitation; affordable and clean energy; decent work and economic growth; industry, innovation, and infrastructure; reducing inequality; sustainable cities and communities; responsible consumption and production; climate action; life below water; life on land; peace, justice, and strong institutions; and partnerships for the goals.

⁵ The ICMA Green Bonds Principles define green bonds as any type of bond instrument where the proceeds will be exclusively applied to finance or refinance, in part or in full, new and/or existing eligible green projects and that are aligned with the four core components of the Green Bonds Principles. The ICAM Social Bond Principles define social bonds as any type of bond instrument where the proceeds will be exclusively applied to finance or refinance in part or in full new and/or existing eligible social projects and that are aligned with the four core components of the Social Bonds Principles.