European high-yield bond issuance with pricing language linked to environmental, social and governance criteria has surged in popularity so far in 2021 with both borrowers and investors, and these sustainability-linked bonds may now even offer issuers a slight pricing advantage when compared to their non-ESG-linked comparables.
"We're moving to a market where, if you're a company that is not embracing ESG, accessing debt will cost you more," said one banker. "But this isn't about greenwashing, and we are not going to tell clients that they can just include green language and save a quarter-point on their deal. You can't wrap a terrible credit in green paper and pay less for it — it all has to start with the credits themselves."
Anecdotally, European high-yield bankers note that ESG-linked transactions typically raise a book 30%-40% larger than their non-sustainable counterparts. This dynamic is driven by larger orders from investors rather than a higher number of orders, sources note, as buyside accounts can place bonds with a sustainable element into a larger number of their own funds, specifically green or ESG funds. The lower-yield environment has also encouraged investment-grade green investment funds to step down the ratings ladder to look at high-yield issuance with an ESG angle, sources add.
Although there has been a surge of sustainability-linked bonds in Europe this year, there has not been sufficient issuance to allow market-wide conclusions to be drawn from the data. However, on an individual deal basis the slight pricing advantage for issuers including sustainability-linked language is visible. For example, the €500 million of sustainability-linked unsecured bonds from glass packaging firm Verallia Société Anonyme priced to yield 1.625%, which compares to an average yield of 1.940% on comparable BB+ rated unsecured issuance to date in 2021, according to LCD. Similarly, in April Lonza Specialty Ingredients completed €460 million of sustainability-linked senior notes backing its buyout by Bain and Cinven to yield 5.25%, which is inside the average yield of 5.58% on CCC+/Caa2 rated unsecured senior notes completed in 2021.
Most notably though, Europe's first sustainability-linked, subinvestment-grade bond deal — namely the €650 million offering from Greece's Public Power Corp. SA (rated B/BB-) — priced in March to yield 3.875%, while a €125 million add-on the following week was completed at 100.75 to yield 3.709%. By comparison in 2021, senior notes of this rating have averaged a yield of 4.890%.
Given the strong demand for the product and the potential pricing discount available for issuers, the volume of both sustainability-linked bonds (where a coupon step-up is typically linked to ESG-related key performance indicators) and green bonds (where proceeds from the deal can be utilized for specific green projects) has risen this year.
Similarly, the number of high-yield bond deals with ESG-related language has stepped up year over year.
"The market is still small, with around 1% of outstanding deals globally, but it's growing," says Andrew Carey, co-head of impact financing and investing at Hogan Lovells. "Regulation suggests there's going to be a greater focus on ESG in the future, and we're getting to a point where all investors have a view on it."
For the year to May 12, ESG-linked issuance accounted for 12% of the European primary high-yield bond market by volume, and 15% by deal count.
The pickup in the volume and number of sustainability-linked high-yield bonds issued so far in 2021 echoes the rise in European leveraged loans completed with ESG-linked margin ratchets over the last 18 months, although there are notable differences developing in terms of how sustainability pricing features are embraced across the two asset classes. The key differential is that on high-yield bonds, issuers face a coupon step-up if they miss their sustainability targets, whereas on leveraged loans, for the most part, both positive and negative margin-ratchets are available to issuers dependent on whether they hit or miss a number of key performance indicators, or KPIs.
The leveraged loan product has also incorporated a larger range of ESG-related KPIs, with between two and five targets being worked into the ratchets on transactions. "In the bond market, targets have been more focused on environmental factors — either on greenhouse gas emissions or energy efficiency — and issuers have tended to be required to meet all the targets laid out for the ratchet to kick in," explains Carey. "There's a level of standardization there. But in loans there's far more variety in the KPIs. That's a market that's far more flexible, and where there's more of a relationship between the investors, the agent, and the company that allows for a more dynamic conversation over the life cycle of the loan about hitting targets."
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