Investors often pay for the improvement from sustainability-linked bonds

Here’s a note from Adrien-Paul Lambillon:

Who pays for #sustainability? In our most recent working paper, Julian Kölbel and I examine the novel phenomenon of sustainability-linked bonds (SLBs), which are bonds with a coupon adjustment linked to the issuer achieving a sustainability target.

We find that in most cases investors pay for the improvement in sustainability, while issuers benefit from a sustainability premium. In other words, investors can have #impact by investing into SLBs. But we also show that there is a free lunch for some SLB issuers: the premium is so large that the issuers benefit even if they fail on their sustainability target. This is the case especially when SLBs are callable, as this allows issuers to reduce the penalty.

The ‘free lunch’ is likely an indication of strong investor demand for SLBs, but it could lead to greenwashing, when SLBs are issued purely for financial optimization without a real commitment for sustainability improvements. Thus, SLBs are a promising #impact #mechanism, but investors need to look at the details to make sure they set the right incentives.