While already commonplace in the investment grade market, a clear trend we are seeing emerge in the Non-IG market is an increase in sustainable and environmental, social and governance (ESG)-linked new issuance. We think this that the trend that is here to stay, and one that will likely only grow in loans and high yield. The Neuberger Berman Non-IG platform engages with and scores individual issuers using our own proprietary ESG scoring system. These new structures reflect that non-IG issuers are increasingly willing to tie their cost of capital directly to their stated ESG goals.
We first saw these types of structures emerge in the European loan market in late 2020. These loans included specific ESG measurement goals that allow the issuers to reduce the coupon on their loans by up to 7.5 basis points if their specific targets are met over the life of the loans. In one recent example, a packaging company issued a loan that contained an ESG-linked margin change of +/- 2.5bps tied to three specific ESG key performance indicators (KPIs) including greenhouse gas emissions, the percentage of post-recycled content in their products and their percentage of women in management. Each of the three KPIs has an independent interest rate ratchet of +/-2.5bps and will be tested annually.
We are also starting to see these structures in the U.S. high yield market as well. Earlier this year, a telecommunications company issued a “sustainability- linked” bond that tied their bond coupon levels to the company’s two greenhouse gas emissions targets. The 8.5- year bond will see the coupon step up by +0.125% in 2026 unless they meet both of their stated targets. However, if they only meet one of the two targets the coupon will be increased by +0.0625%.
We anticipate that underwriters and issuers will continue to look to these types of structures, and we applaud the move by companies to directly link their borrowing costs to their ESG goals. However, we also think it’s important for issuers and investors to make sure the stated goals can be monitored and measured in a transparent way, and preferably externally audited. In addition, we believe it’s important for the structures to cut both ways – issuers that get coupon step- downs upon achieving their stated goals should also be open to coupon increases if they come up short of their targets. We think these emerging structures will help further align issuers and investors around important ESG goals.