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S&P podcast: NRG's sustainability-linked bond as a new tool to lower emissions

➤ Integrated power company NRG Energy recently rolled out sustainability-linked bonds to help finance the acquisition of energy retailer Direct Energy

➤ Sustainability-linked bonds penalize the company for not hitting sustainability targets, adding consequences to proposed environmental targets

➤ While more flexible than green bonds, the market for such bonds is still limited and does not fully replace more conventional financing

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Gaetan Frotte, senior vice president and treasurer, NRG Energy Inc.
Source: NRG Energy

NRG Energy Inc. recently issued $900 million in senior notes as a sustainability-linked bond tied to a key performance indicator and associated sustainability performance target in line with the United Nations' sustainable development goals.

The bonds are a part of a $3.83 billion round of securities offerings to finance NRG's acquisition of Direct Energy LP. Unlike green bonds, sustainability-linked bonds can set environmental targets but do not necessarily tie the proceeds solely to specific new or existing projects with environmental benefits.

NRG targets absolute greenhouse emissions of 31.7 million metric tons of carbon dioxide equivalent by the end of 2025. That is compared to 37.0 million metric tons of carbon dioxide equivalent in 2019. The goal includes the company's emissions from electric power production, emissions generated from electricity consumed by the company and employee business travel.

S&P Global Market Intelligence interviewed Gaetan Frotte, senior vice president and treasurer at NRG, about the company's new sustainability bond and how financial tools can play a role in the energy transition for the latest episode of the Energy Evolution podcast, available on Apple Podcasts, Spotify, and other platforms. Below is an edited and condensed version of that conversation. The full interview is available on the podcast.

S&P Global Market Intelligence: Tell us a little bit more about the strategy here. Why link these bonds to targets where the company could be penalized for not hitting them? Why is that more effective than just publicly announcing that you have emissions goals?

Gaetan Frotte: I think that for many companies and for many investors, especially investors, there is some skepticism about what companies will do. Even though there are some big announcements, that they will do what they say in their plan. Putting in place these types of bonds shows that we're serious about it, and there is a penalty if we don't do what we say. It's very effective.

In our case, it allowed us to also start the dialogue with some investors and reach out to investors that we wouldn't have been able to reach out to before. It was very positive from that standpoint.

Can you tell us a little bit more about how you're going to measure your success on these ambitions? Who is it that determines whether the company has hit those goals?

We've been reporting on our sustainability goals for the last ten years. We've issued on an annual basis, a sustainability report that's available on our website. That's a very comprehensive report that summarizes basically all of our efforts and all of our goals. We are already reporting on our emission reduction goals. We do that on an annual basis. We report it. It's actually audited by our auditor KPMG LLP.

We will continue to do that for the foreseeable future, including for this bond in particular.

Here, what we've done is based on our emissions, back in 2014, which was at 63.3 million tonnes of CO2 emissions, our goal is to reduce this by 50%. So a reduction of 31.7 million tonnes of CO2. We will measure that improvement. I'm happy to say that we're already 83% towards that goal at this stage. We'll continue to measure that improvement until 2025. We will make that number public and basically announced whether or not we've met that goal and whether or not we have to pay that penalty on the bonds. It will be audited by a third party.

This $900 million package of senior notes is part of a broader offering of securities that came with the acquisition of Direct Energy. Why is just a part of this issuance linked to the sustainability targets? Why isn't that whole package tied to climate goals?

We issued a total of $3.8 billion of debt during the same week. Part of it was broken down into a number of tranches with different maturities. Unfortunately, the demand at this stage for this type of sustainable instrument is more from what I would call investment-grade investors, as opposed to high-yield investors. So there was some limitation already in the types of instruments that we could issue that could be deemed sustainable and attractive to sustainable investors from that standpoint.

The other aspect is the tenure of those bonds. Our key performance indicator here, on emission reductions, was a 50% target for 2025. So it was well-fitted for an instrument that would be more than five years, which basically was attractive for a seven-year instrument.

What do you think is the future for deploying these types of securities issuances for NRG? Are more on the way?

Yes, I think so. I think sustainable bonds are going to be very attractive for a number of issuers that cannot issue green bonds because they might not have the use of proceeds for them. This is a more flexible instrument that can be used by a number of other issuers, across industries and across companies.

So would you expect this type of bond to become more common across the broader power and utility sector in the next year to five years?

Yes, I believe so. There's actually a number of instruments that are being created, some innovation, so to say, in the finance markets. The green bonds are now very prevalent, but again cannot be used by everybody. I think that sustainable bonds will increase. There are also some transition bonds a number of companies in the energy sectors might be issuing as well, on their way to transitioning their carbon-based business.