The market for sustainability linked bonds is facing significant headwinds, with issuance declining sharply in 2024. This sudden drop has raised questions among bankers and investors about the future of the $319 billion market. So far, SLBs have only raised $37.6 billion this year, almost half the amount raised in all of 2023. There has been sharp decline in SLB popularity after the victory of Donald Trump in the US presidential election and the broader backlash against Environmental, Social, and Governance initiatives. Trump’s anti-climate agenda is expected to further weigh on fundraising efforts.
Sustainability linked bonds are a type of debt instrument that ties a company’s borrowing costs to its achievement of specific ESG targets. Unlike traditional or green bonds, SLBs are not designated for specific green projects. Instead, they incentivise companies to improve their overall sustainability performance.
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Despite their innovative design, SLBs have faced criticism for greenwashing and the challenges of tracking sustainability goals. Europe, the largest market for these bonds, has introduced tougher regulations, further unsettling the market. Additionally, the disappearing greenium a— a discount offered to borrowers for issuing green or sustainability linked bonds — has diminished interest in this once-thriving market that peaked in 2021.
Sovereign sustainability linked bonds
Sustainability linked bonds are not limited to private sector issuances. Sovereign SLBs, which link sovereign debt to national climate and environmental commitments, have emerged as a promising tool for developing countries. In 2022, Chile and Uruguay became the first countries to issue sovereign SLBs, with issuances of $3 billion and $1.5 billion, respectively. These bonds tied their financial characteristics to key performance indicators such as greenhouse gas emissions reduction and native forest retention.
Uruguay’s sovereign SLBs garnered substantial foreign investment, with buyers from Europe, Asia, the United States, and Latin America. This influx of investment highlights the potential of sovereign SLBs to broaden access to international finance, especially for low- and middle-income countries grappling with climate challenges, the COVID-19 pandemic, and debt crises.
However, sovereign SLBs have yet to be issued at concessional rates, raising questions about their appeal compared with other forms of sovereign debt. Critics also note that these bonds may lack additionality — the assurance that funded activities would not have occurred without the financial instrument. Nonetheless, they encourage effective decarbonisation policies and increase access to global capital.
Investor concerns and market dynamics
The SLB market is experiencing a significant decline with investors finding it challenging to track performance indicators and verify ESG target achievements, making green bonds a more attractive alternative due to their simpler due diligence process. Notably, the US, one of the most active markets for SLBs globally, has not seen any deals in 2024.
With dwindling demand, companies are increasingly favouring green bonds or sustainability linked loans, which are privately arranged between banks and issuers and face less market scrutiny.
Investors prefer green bonds
Green bonds differ from SLBs in their specific focus and appeal. These instruments are designated for environmentally friendly projects, offering investors greater clarity and confidence in the positive impact of their investments. Projects funded by green bonds include renewable energy, energy efficiency, and other green initiatives, allowing investors to directly track fund utilisation.
The green bond market’s longer track record and established credibility further enhance its attractiveness. In 2024, green bonds are on track to raise $685 billion, led by the US, marking the highest total on record.
Beyond green bonds, the broader sustainable debt market is thriving. Total sustainable debt issuance has surpassed $1.49 trillion this year, exceeding 2023 levels and reversing two years of declines.
The decline in SLB issuance has been most pronounced in the Americas, where volumes have fallen by nearly 90% this year. In the Europe, Middle East, and Africa region, issuance has declined by about 30%, while Asia-Pacific has seen a more modest drop of 8%, according to Bloomberg Intelligence data. Notably, Asia’s SLB issuance has surpassed that of the Americas for the first time.
Sovereign SLBs and budgetary control
Sovereign SLBs offer significant advantages for developing countries by providing access to international finance without stringent conditions on budget allocation. Unlike debt-for-nature swaps, which often mandate high transaction costs and specific green expenditures, sovereign SLBs allow countries to retain control over their budget priorities. This flexibility aligns with principles of climate justice and self-determination, making sovereign SLBs an attractive alternative for nations seeking to balance sustainability goals with broader development objectives.
However, the feasibility of sovereign SLBs depends on sufficient investor confidence in a country’s ability to repay its debts. This reliance on financial stability limits their applicability in high-risk or highly indebted countries, where traditional conservation finance instruments might still dominate.
India breaks the mould
India has recently ventured into the sustainability linked bonds market. In August 2024, the Securities and Exchange Board of India (SEBI) expanded its sustainable finance framework, introducing new instruments such as Social Bonds, Sustainable Bonds, and SLBs alongside existing green debt securities.
Unlike global trends, SLBs in Indian real estate are gaining traction. Developers and Real Estate Investment Trusts (REITs) are leveraging these instruments to fund eco-friendly projects, aligning with India’s commitment to achieving net-zero emissions. SLBs allow developers to attract ESG-conscious investors while integrating sustainability into their business models.
However, the success of SLBs in India hinges on transparency and measurable sustainability targets, which pose challenges for smaller developers. Despite these hurdles, the nascent SLB market in India presents unique opportunities to support the country’s sustainable development goals, attract foreign investment, and enhance its reputation as a responsible financial market.
The decline of the sustainability linked bonds market highlights the challenges of navigating the evolving ESG landscape. While green bonds and other sustainable debt instruments continue to thrive, SLBs face hurdles that must be addressed through improved regulations, transparency, and investor confidence. Sovereign SLBs, in particular, offer a promising avenue for developing countries to access international finance while retaining budgetary control.
India’s proactive approach to expanding its sustainable finance framework offers a glimpse of how innovative financial instruments can contribute to global sustainability goals. Revitalising the SLB market requires a concerted effort to rebuild trust and demonstrate the tangible impact of these instruments in driving positive change.