CALGARY⁠ — When the pipeline giant Enbridge issued a US$1-billion bond last June as part of a broader fundraising effort, it came with a caveat. The Calgary-based company would have to meet an array of social and environmental targets over the bond’s 12-year repayment period⁠—and pay higher interest costs should it fail to do so.

The debt was issued as a sustainability-linked bond (SLB), a relatively new but fast-growing class of debt in which borrowers set specific environmental, social and governance goals in exchange for slightly more favourable terms.

Despite their relative novelty, these instruments have seen a meteoric rise in popularity in recent years, transforming sustainable debt markets and threatening to eclipse older products like green bonds. While their rapid uptake has spurred greenwashing concerns, the tools could nonetheless carry wide-reaching benefits for companies, validating their ESG efforts while providing some cushion against rising interest rates.

Companies including Telus, clothing company H&M and Italian multinational oil producer Eni SpA have all issued SLBs beginning in 2020, each with specific ESG targets. H&M will have to cut emissions from its operations by 20 per cent by 2025. Enbridge’s SLB commitments are linked to its overall targets, which include reducing emissions intensity by 35 per cent below 2018 levels by 2030, and ensuring that its board is 40 per cent women by the end of 2025.

Unlike green bonds, where proceeds must be spent on defined environmental projects, SLBs and their equivalents—like sustainability-linked loans (SLLs)—can be used for general purposes. 

Both sustainability-linked products have seen massive uptake in recent years. SLBs and SLLs are the fastest-growing segment of the market for sustainable debt over the last two years, according to TD Bank, and are now neck-and-neck with green bonds in terms of overall debt issued in 2021. Sustainable-bond issuances increased nearly tenfold between 2020 to 2021 alone, from US$11 billion to US$108 billion, according to TD data. Loans ballooned 274 per cent from US$130 billion to US$487 billion over the same period. TD itself has underwritten more than $21 billion in sustainable bonds since 2010.

The astronomical growth wasn’t entirely a private-sector affair. The European Central Bank started buying up SLBs as part of its quantitative-easing program during the pandemic, while the executive branch of the European Union, the European Commission, said it would fund a third of its COVID-19 recovery program with US$262-billion in green bonds.

Debt managers and analysts say businesses are drawn to sustainable debt for several reasons, primarily the growing pressure to meet ESG requirements. Another is their relative flexibility compared with green bonds, which long dominated sustainable-debt markets.

Many see a long future for sustainability-linked bonds and loans, saying they can fetch a green premium, or “greenium,” on the market, similar to the way green bonds have. The term was initially used to describe investors’ willingness to pay higher prices or accept lower yields in exchange for sustainability. 

“I think we can apply the same principle to the SLB market,” said Susan Thompson, director of sustainable finance at TD. “What issuers see right from the onset is a lower cost of capital by way of a lower coupon when compared to a traditional bond, all things being equal.” 

That already appears to be proving out. Enbridge, which issued its first SLB in June 2021, came back to the market months later with another $1.1-billion batch of bonds that sold for 10 basis points higher than a conventional bond would have, according to one analyst. The company has now issued about $2.3 billion in SLBs. H&M’s €500-million bond was 7.6 times oversubscribed, the company said in a release. 

In a statement, Enbridge spokesperson Gina Sutherland said issuing the SLBs put new emphasis on the company’s ESG commitments. 

“Simply put, it makes us more accountable by tying our achievements to borrowing costs. If we don’t meet our goals, our borrowing costs go up,” she said. 

Ryan Riordan, a professor at Queen’s University’s Smith School of Business and the research director of its Institute for Sustainable Finance, said products like SLBs send a signal to the markets that companies are thinking about their longer-term survival. 

“It reduces risk,” he said. “A financial institution that is lending money to an organization that’s looking at their long-term impact on the environment is going to be less risky than one that doesn’t.” 

Sustainability debt has also become more of a key instrument in the era of rising interest rates, Riordan said, as the “greenium” between traditional debt and green debt is expected to widen. The premium on green bonds, for example, was negligible when interest rates remained near decade-lows, but that gap will become more defined as costs of capital increase more generally. 

“Let’s say you’re not getting five basis points, but maybe getting 10 or 20, or 40 or 50—then all of a sudden, these things are just much more important and also much more measurable,” he said. 

The growth of sustainability-linked bonds has, however, fed concerns over greenwashing, or that the targets tied to the debt don’t actually produce environmental benefits. Investors have raised doubts about the key performance indicators in a recent US$5-billion SLB issued by Israeli pharmaceuticals company Teva, for example, saying its emissions-reduction targets lacked ambition. 

That could lead to growing demand for platforms that can track things like carbon emissions or water consumption, said Alex Todorovic, founder and CEO of Calgary-based startup Arbor, which uses data to help clients oversee their environmental programs.

Such tools could in turn become crucial for companies managing and controlling their debt obligations. Arbor is already working with Nudnik, a children’s-clothing company based out of Toronto, and has been in talks with the federal government and Canadian Tire to potentially supply its technology to track their climate-related progress. 

“You need to showcase that you are actually reducing your carbon footprint by the agreed amount,” he said.