Making Sense of ESG Bond Structures

We’re optimistic that environmental, social and governance (ESG)-linked bonds will help create a better, more sustainable world. And investors are just as eager to buy these bonds. But with the recent proliferation of ESG bond structures, the investment landscape has become more complex—and potentially confusing.

Assessing an ESG bond means delving deeper than an issuer’s financials, into the bond’s governing framework and its fit with the overall sustainability of the issuing company. In other words, to make the right investment choices, investors must understand the different structures and their investment implications.

Many investors are already familiar with green bonds, which have been on the market since 2007. Green bonds finance a specific project or projects with an environmentally beneficial purpose. Since then, companies have issued new types of bonds to finance a range of green, social and sustainable projects (Display).

The most recent innovation—the key performance indicator (KPI)-linked bond—is a target-based structure. It incentivizes the issuing company to achieve higher ESG standards across the business, rather than to finance a specific project. Such initiatives give issuers considerable flexibility in raising capital on ESG-linked grounds.

The proliferation of ESG-linked bonds means investors need to be aware of the technical distinctions and the investment implications of each type.