Addressing Concern About SLBs With Enhanced Targets and Structure

SGX RegCo’s Joanne Teo and Michael Tang discuss the use of sustainability-linked bonds to finance transition efforts and how to enhance the credibility of such instruments.

The world is in a state of climate emergency and climate change mitigation and the transition to Net Zero has become more urgent. Enabling efforts towards these goals is thus increasingly important. An average of USD 9.2 trillion a year are needed globally to achieve net-zero in 2050, according to consulting firm McKinsey1.

As part of such financing, about USD 778.7 billion2 of green, social and sustainability (GSS) bonds were issued in 2022. Singapore Exchange (SGX Group) identifies GSS bonds listed on the exchange that meet recognised standards as Sustainable Fixed Income instruments. More than 100 GSS bonds have applied for and obtained recognition under the initiative since its November 2022 launch. However, recognition of a different class of sustainable debt, namely sustainability-linked bonds (SLBs), under the initiative has been kept under review.

SLBs are a relatively new instrument for issuers to raise funds. They were first issued in 2019 by Italian energy firm Enel. An SLB issuer must set sustainability performance targets (SPTs) which in turn generally affect the characteristics of the bond, usually the coupon rate. In return, the issuer of an SLB has unfettered use of the funds raised. Despite the flexibility in the use of funds, SLBs have been slow to take off. Just USD 76.4 billion3 were issued in 2022, less than 10% of the total issuance of their GSS bond counterparts. One of the main factors behind the slow progress of SLBs is concern about credibility arising from fears of greenwashing.

Consider then the global situation of urgent need for financial support to companies and even countries in their transition towards Net Zero. The problem is particularly pronounced in Asia. The region “faces a tough balancing act in decarbonisation given our growing energy demands as economies rapidly develop”, said Indranee Rajah, Singapore’s Minister in the Prime Minister’s Office and Second Minister for Finance and National Development, in her speech4 at the International Capital Markets Association’s (ICMA) 9th Annual Conference of the Principles. As she noted, “we cannot adopt a binary approach of choosing between sustainability and livelihoods. Leveraging transition finance will allow us to move forward with practical ambition”.

The ability for more issuers, particularly those operating in brown or hard-to-abate sectors, to use SLBs as a form of transition finance is therefore compelling. Traditionally, these same issuers may not be able to tap the capital market via GSS bonds if they do not have green expenditure requirements because proceeds of such bonds can only be allocated to eligible green projects such as the construction of green buildings or renewable energy production. With SLBs on the other hand, these issuers instead must commit to deliver on a transition plan beyond a business-as-usual trajectory during the bond tenor, such as to meet decarbonisation benchmarks. SLB issuers are not bound to use proceeds raised for specific projects and instead can flexibly use the funds to support their transition strategy.

For SLBs to become more widely adopted, two matters must be addressed: the credibility of the SPTs and the product structure.

Credible SPTs

Some SLB issuers have been criticised for setting SPTs that are not material to their business, do not cover all material scopes of their carbon footprint, or are insufficiently ambitious. In one high-profile example, Brazil’s JBS, the world’s largest meat producer, was accused5 of misleading investors as the targets for its USD 3.2 billion SLBs (one of the largest SLB issuances in 20216) did not include scope 3 supply chain emissions, the company’s primary source of greenhouse gas emissions.

A leading market standard for SLBs is the Sustainability-Linked Bond Principles that ICMA publishes. ICMA is an association comprising private and public sector debt issuers, banks and securities dealers, asset and fund managers and other participants in the debt securities market. ICMA’s Sustainability-Linked Bond Principles require key performance indicators (KPIs) to be relevant, core and material to the issuer’s business and for these indicators to be benchmarked7. ICMA has also produced an illustrative registry8 of KPIs that are material to each sector and the global benchmarks that issuers can refer to for calibration of their targets. The registry however is intended as a guide and adherence is not compulsory.

Perhaps what the market needs are for the SLB standards to mandate SPTs to be developed by third-party experts using credible benchmarks, rather than by the issuers themselves. For example, the Climate Bonds Initiative has a suite of sector criteria, developed with external experts and which are subject to public consultation. The Climate Bonds Sector Criteria set science-based benchmarks for each sector that are aligned with the Paris Agreement, and specifically to a 1.5°C increase in temperature above pre-industrial levels. The criteria cover several sectors, including hard-to-abate ones such as steel and cement production.

Earlier this year, the Climate Bonds Initiative updated its Climate Bonds Standard – which requires issuers to meet the sector criteria as well as other requirements (e.g. disclosure) – to enable the certification of SLBs and entities overall9. SLB issuers can therefore obtain certification and benchmark their targets with the Climate Bonds Sector Criteria, giving investors assurance on the scientific rigour of the SPTs.

Product structure

For SLBs to work as they should, issuers must have sufficient skin in the game in terms of achieving their commitments.

The most commonly adopted mechanism is the step-up model, where an issuer pays bondholders a higher coupon (i.e. a coupon step-up) if the issuer misses one or more of its targets. According to a Federated Hermes10 report, 85% of SLB issuers adopt this model. Significantly, over 60% of SLBs set their coupon step-ups at 25 basis points, suggesting that the bonds’ original coupon and the issuers’ credit quality or scale are not considered.

Investors may not be thrilled by the adoption of 25 basis points as the almost-standard coupon step-up rate regardless of the economics for the specific bond and the issuer’s financials. The European Securities and Market Authority has gone as far as to suggest that SLB issuers may potentially be benefiting from a “free lunch” by reducing their cost of capital from the sustainability premium while limiting financial penalties for missing their targets.

Other penalty-minimising mechanisms have also been identified. For example, a study from the World Bank11 found evidence that SLBs are more likely to include call options than corporate green bonds or conventional corporate bonds. Such call options allow issuers to redeem the SLB before the target observation date and evade potential penalties before they miss any target. The same study also found that issuers of SLBs with step-up penalties tend to set later target dates for their SLBs, suggesting that this is done to minimise potential penalties for failing to achieve outcomes.

ICMA12 encourages issuers to set a target observation date and penalty payment date before the call date of the bond. It also recommends issuers set intermediate observation dates for the SPTs. The Climate Bonds Standard goes further to impose mandatory safeguards. To qualify for certification, SLBs cannot mature or become callable before the date of the first interim target. The Climate Bonds Standard also prescribes interim SPTs to be set on a three-yearly basis for the term of the SLB and a five-yearly basis thereafter, up to the date the activity is intended to hit net zero emissions or 2050, whichever is sooner.

The takeaway is that there must be adequate levers to ensure that issuers are accountable for the targets they set. Non-financial repercussions are also useful motivators. For example, if SLB issuers fail to deliver on their targets, the Climate Bonds Standard require the under-performance to be remedied within 12 months or certification may be rescinded. Certification may also be rescinded if SLB targets are reset at a lower level than those in place at the time of certification. This consequential reputational damage provides another layer of safeguard for investors, aside from compensatory measures.


SLBs are undoubtedly another attractive way to channel much-needed financing to transition efforts. Convincing investors about the credibility and robustness of SLBs is not unsurmountable. As with any other investment product, safeguards must be put in place to assure investors that their concerns including greenwashing risk and commensurate risk-reward factors are addressed.

To achieve this, issuers should comply with current market guidelines on SLBs, appoint external reviewers to conduct a rigorous review against the SLB requirements pre- and post- issuance and disclose areas of non-compliance. Issuers can also consider adopting robust certification standards for their SLBs, such as that under the Climate Bonds Standard, to signal their commitment to the market.

Joanne Teo is Vice President of Listing Policy & Product Admission (LPPA), Singapore Exchange Regulation (SGX RegCo) while Michael Tang is Executive Director and Head of LPPA and the Sustainable Development Office, (SGX RegCo)

1 McKinsey Global Institute, “The net-zero transition: What it would cost, what it could bring”, January 2022
2 Climate Bonds Initiative, “Sustainable Debt Global State of the Market 2022”, 18 April 2023
3 Climate Bonds Initiative, “Sustainable Debt Global State of the Market 2022”, 18 April 2023
4 Speech by Ms Indranee Rajah, Minister in the Prime Minister’s Office, Second Minister for Finance and National Development, ICMA 9th Annual Conference of the Principles, 28 June 2023
5 A complaint was filed by Mighty Earth to the US Securities and Exchange Commission on this matter.
6 Financial Times, “Brazilian beef giant faces SEC greenwashing complaint”, 18 January 2022
7 ICMA, SLB Principles, June 2020
8 ICMA’s illustrative KPIs registry is found here.
9 The Climate Bonds Initiative may certify these SLBs as “Aligned” or “Transition” depending on whether the issuer is fully aligned at the point of issuance or is only able to do so by 2030.
10 Federated Hermes Limited, “Do Sustainability-linked bonds have a step-up problem”, 23 March 2022
11 World Bank Group, “Structural Loopholes in Sustainability-Linked Bonds”, October 2022
12 ICMA, SLB Principles – Related Questions, June 2022

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