The concept of sustainability-linked bonds (SLBs) lines up well with transition finance. Issuers set targets for, for instance, emissions reduction and, if they meet them, are rewarded with an improved credit margin during the life of the bond. Issuance was initially positive in the wake of the first such deal – by Enel, in 2019 – but the structure has rapidly fallen out of favour.

National Australia Bank’s head of sustainable finance, David Jenkins, says: “Sustainability-linked issuance volume has plummeted in Europe. There was a flurry of corporate issuance but last year many of the issuers were taken to task for having soft targets, minimal reporting or carveouts in the documentation allowing issuers to call or pre-pay without penalty.”

Jenkins remains positive about the future of the asset class but says the problems have to be resolved. “I believe sustainability-linked lending will continue to grow, but it will have to confront the challenges of credible baselining, reporting and ambitious targets,” he adds. “It won’t be enough to rush to get a deal done and therefore put something into the market that is fairly opaque in its targets and ambition.”

The sustainability-linked loan (SLL) market is facing the same challenges as SLBs. Jenkins says some early SLL borrowers have not just refinanced in the format but have also sought to upgrade their facilities’ ambitions. But, he adds, new borrowers in the labelled loan space have been more inclined to go for a use-of-proceeds option.

Nevertheless, it may be the loans arena where some of the difficulties get worked out. “Time to market is a little different in the loan space, especially when we factor in the evolution of sleeper clauses where there is an agreement to convert facilities in the future,” Jenkins suggests. “This can’t be done in bond deals, where issuers need to hit the market with a fully documented security when the option is available.”

Fiona Trigona, NBN Co’s executive general manager and group treasurer, adds: “Issuing in sustainability-linked format is far less flexible than issuing use-of proceeds green or sustainability bonds. Companies may also have issues obtaining board approvals to link financing with meeting certain sustainability metrics.”

More fundamentally, some issuers say the incentives on offer even to explore sustainability-linked financing may be insufficient to induce borrowers to work through the inevitable complexities of the sector.

For instance, Contact Energy’s corporate treasurer, Will Thomson, says: “If we’re talking about 25 basis points up for the final two years of a seven-year bond, it’s not that material for a corporate borrower. My sense is that issuers have settled back into thinking that green is understandable and is something they can commit to over the life of a bond.”