ICMA updates to the Sustainability-Linked Bond Principles Q&A

On 26 September 2023, the International Capital Market Association (ICMA) and the Executive Committee of the Principles updated its Q&A (Q&A) related to Sustainability-Linked Bonds (SLBs).

The Q&A are intended to complement the Sustainability-Linked Bond Principles (SLBP), providing additional information on how to interpret the guidance set out in the SLBP and to illustrate practical application on transactions reflecting market developments in this product. These Q&A replace the 2022 version.

The main updates relate to selection of key performance indicators (KPIs), considerations for selecting credible sustainability performance targets (SPTs) and reporting requirements under the SLBP. In addition, the Q&A now contemplate sovereign issuers throughout.

The guidance confirms the possibility of ‘green’ CapEx as a KPI. This could be appropriate where this type of investment is central to the transition strategy of a particular industry or as a means of demonstrating commitment and progress towards reducing GHG emissions where it is not possible to include a Scope 3 GHG emissions KPI/SPT. In this respect it is noted that external references such as the EU Taxonomy can play an important role in providing additional context given there is currently no global definition of ‘green’ CapEx.

The relevance of the Climate Transition Finance Handbook is also highlighted, particularly where climate change is core, relevant and material for an issuer and for issuers with GHG emission reduction and performance targets. Whilst it is not a requirement for issuers to select independently validated science-based targets, it is recognised that where feasible this will be best practice; it is however strongly recommended that issuers establish ambitious targets aligned with any existing credible decarbonisation pathways for a particular region or sector.

Whilst acknowledging that SPT targets can be achieved via M&A activity, the Q&A emphasise the need for issuers to provide investors with appropriate disclosure regarding the impact of such M&A activity on the SLB’s ambitions and characteristics and also tying such M&A activity to the overall ESG strategy in order to maintain credibility of such target.

The Q&A have also been updated to more strongly recommend that issuers structure their SLBs such that the target observation date/payment of penalty date is set before any call date and expand upon the existing guidance around monitoring and publishing performance against SPTs and considerations in relation to any recalculation of KPIs/SPTs.

Further guidance is also included on meaningful incentive mechanisms in SLBs and potential alternative adjustments to financial characteristics, beyond the coupon-step up structure that has dominated market practice to-date.

Finally, the updates shed additional light on the types of information expected to be disclosed in order for issuers to meet reporting obligations under the SLBP and instances where failure to report should result in a triggering event for adjustments to bond characteristics, such as a coupon-step up.

The Q&A aim to address a range of topics at a time when the SLB product continues to evolve. New issuer sectors and types, as well as novel features, are regularly being introduced to this market. It remains challenging to promote a one-size-fits-all approach to many aspects of the product since KPIs and structural features need to be tailored to the relevant issuer. We will no doubt see many of the topics covered in the Q&A the subject of on-going discussion as the market evolves to enhance the credibility and robustness of the product.