Private equity companies, traditionally controversial players in the finance industry, are now positioning themselves as leaders in sustainability. This move raises questions about whether their efforts are genuine or just a marketing ploy. In the next report on the Moral Money Forum, we will delve into this topic and explore the role that the private equity sector can play in addressing environmental and social challenges. We value the input from our readers and encourage you to participate in our short survey on this matter.
New bonds known as Sustainability Bonds (SLBs) have been issued by some of the world’s largest polluters, including airlines and meat packers. These bonds aim to raise funds by offering a lower interest rate if the issuer meets sustainability targets. However, French academic Julien Lefournier argues that SLBs are “doomed to fail” because corporate treasurers find the inherent gambling nature of these bonds unacceptable. Issuers have an incentive to manipulate the bond’s key metrics to minimize the penalty for not meeting the targets. Evidence suggests that these metrics are indeed being manipulated, raising concerns about the credibility and effectiveness of SLBs.
To illustrate this point, a debut SLB issued by UK Heathrow Airport was analyzed. While the bond’s penalty for not meeting the target is high and the goal of reducing aircraft emissions by 15% by 2030 is ambitious, the probability of failure is presumed to be low. This raises the question of how impactful SLBs are in driving real change in the economy. Lefournier’s argument provides an interesting perspective that anti-ESG Republicans in the US can consider.
Various solutions have been proposed to address the weaknesses of SLBs. The UK’s Financial Conduct Authority is exploring the idea of urging bond issuers to disclose the criteria for an ambitious and meaningful target and how the penalty will incentivize compliance. Ulf Erlandsson suggests the use of “greenback” tools, which would have a penalty of at least a dollar and a significant chance of winning, to encourage bondholders to offer cheaper capital upfront. However, dynamic pricing models for SLBs are still in their early stages, and their effectiveness ultimately depends on the actions of regulators and market participants.
In conclusion, the private equity industry’s increasing focus on sustainability raises questions about their genuine commitment to addressing environmental and social challenges. The effectiveness of Sustainability Bonds (SLBs) in driving real change is also being called into question due to concerns over the manipulation of key metrics. However, there are potential solutions to address these weaknesses and make SLBs more impactful. Further research and collaboration between regulators and market participants are necessary to refine these financial instruments and ensure their effectiveness in promoting sustainability.
—————————————————-
| Article | Link |
|---|---|
| UK Artful Impressions | Premiere Etsy Store |
| Sponsored Content | View |
| 90’s Rock Band Review | View |
| Ted Lasso’s MacBook Guide | View |
| Nature’s Secret to More Energy | View |
| Ancient Recipe for Weight Loss | View |
| MacBook Air i3 vs i5 | View |
| You Need a VPN in 2023 – Liberty Shield | View |
Receive free ESG investing updates
We will send you a myFT daily digest email rounding last ESG investments news every morning.
This article is an onsite version of our Moral Money newsletter. Registration Here to receive the newsletter directly in your inbox.
Visit our Center of Moral Money for all the latest ESG news, opinion and analysis from the FT
Good morning. Imagine a shoebox of any width, length or height. If one of its sides measured zero centimeters, you couldn’t fit any shoes into it, however small your feet are and however large the other sides of the box.
The same logic shows that so-called sustainability bonds will not help finance the energy transition, due to the incentive to gamble at least one of its attributesJulien Lefournier, a former banker at Crédit Agricole, argued in an article last month for research group Chair Energy & Prosperity. The group’s backers include the utility company Engie and Caisse des Dépôts, an investment arm of the French state.
About $60 billion of the popular new type of green bond was issued in 2022. Top issuers this year include French supermarket Carrefour, state-controlled Italian utility Enel and Chilean debt bureau. They make the issuer, acquirer, and structuring bank look okay, but do they serve some other purpose?
Today I delve into this intriguing framework that seeks to create a unique market-driven critique for failures on sustainability issues and share my analysis of what anti-ESG Republicans in the US can learn from them.
Let us know what you think about the questions I raise about the (sometimes tenuous) link between green finance and the real economy by commenting below or writing to moralmoneyreply@ft.com. — Kenza Bryan
Few parts of the finance industry have been more controversial than the private equity industry. Yet PE companies are now making serious efforts to position themselves as leaders in sustainability. Is this a mere marketing ploy or can this sector play a vital role in tackling the world’s greatest environmental and social challenges? This will be the focus of our next report on the Moral Money Forum, and we want to hear from our readers. Click here to fill out our short survey.
Four reasons to be wary of new bonds
Some of the world’s biggest polluters, from airlines to meat packers, have rushed to issue so-called Sustainability Bonds (SLBs). These raise generic money, with the threat of a higher interest rate if the issuer fails to meet a sustainability target.
In theory, this should funnel the cheapest capital to governments and businesses with the most ambitious decarbonization goals, whether they sell crude oil or solar panels. The greater the chance of cashing in on a missed target in the future, the greater the incentive for a bondholder to accept a lower-than-usual yield upfront.
But when it comes to making progress on climate change, they are “a bad product, doomed to fail,” argues French academic Julien Lefournier, because cost-of-capital gambling is “abhorrent” to corporate treasurers.
Issuers have an inherent incentive to reduce at least one of the bond’s three key metrics to near zero: the size of the penalty, its duration, and the likelihood that the target will be missed. If only one metric is played out, the future win for the bondholder becomes too small to justify offering a lower interest rate up front, making it largely pointless.
Academics, activists and regulators have all reported evidence that these metrics are indeed being manipulated. Imtiaz Ul Haq and Djeneba Doumbia, economists with the World Bank group, found that the average increase is about one-tenth of overall coupon rates (and has stagnated as interest rates have risen). They also found that penalties typically only take effect a few years before the bond matures, and the the higher the coupon, the closer to maturity this is. This was highlighted by the Financial Conduct Authority in the United Kingdom goals are sometimes too weak to be credible.
A fourth area of weakness was identified in a Bloomberg New Energy Finance report earlier this month. SLBs are more often “callable” than regular bonds, meaning companies can simply withdraw them by repaying principal early. “They are full of exit clauses, inadequate terms and conditions, vague deadlines and opaque goals,” wrote its author.
I tried to apply these four tests to a €650m debut SLB that UK Heathrow Airport rolled out to great fanfare earlier this month. The fine of up to one percentage point above the existing rate is unusually high. While this would only be paid from 2030, the bond cannot be called early. Finally, its main goal is reasonably impressive: a 15% reduction in aircraft emissions by 2030, through a combination of switching to more sustainable fuel and using less of it.
But what about the probability of failure? Low, presumably. The 2030 emissions reduction target is at the heart of Heathrow’s net zero commitment to investors. It’s hard to imagine the company betting big against the risk of an embarrassing flop.
Lefournier is a rare voice trying to lend mathematical credence to the skeptical view that green finance, in its current form, has little impact on the real economy. This is an idea anti-ESG Republicans in the US would do well to tune into; leads to the conclusion that portraying ESG investing as a bogeyman is rather pointless.
While the French journal is chock full of equations, what it lacks – other than a formal peer review – is imagination.
A lot of solutions have been proposed. The UK’s Financial Conduct Authority, for example, is exploring whether to “urge” bond issuers to disclose in prospectuses what makes a target “ambitious and meaningful”and how the sanction will incentivize them to comply.
Ulf Erlandsson – another former investment banker, who now heads the Anthropocene Fixed Income Institute, a think tank – argues SLB “greenback”.. These tools would have a penalty of at least a dollar and at least half the chance of winning. That should persuade bondholders to offer cheaper capital up front, Erlandsson says.
He rightly acknowledges, however, that dynamic pricing models for SLBs are “still in their infancy” and that financial instruments are what regulators and market participants make of them. (Kenza Bryan)
Smart reading
A new special report from the FT highlights some of the more interesting research related to sustainability happening in leading business schools, on topics ranging from carbon pricing to food processing.
—————————————————-