Sustainability-linked bonds offer investors a way to align their investments with measurable environmental outcomes, while also serving as a test of both government policy credibility and environmental ambition, according to Ninety One.
Sustainability-linked bonds (SLBs) and biodiversity-focused structures are beginning to find their place within emerging market (EM) sovereign debt, according to Nicolas Jaquier, co-portfolio manager of Ninety One’s EM sustainable blended debt strategy.
Although issuance remains relatively small, SLBs are giving investors a way to tie investments to measurable environmental outcomes, according to Jaquier.
In addition to this, SLBs can serve as tests of both the credibility of government policy as well as environmental ambition, with several countries, including Chile, Uruguay and Côte d’Ivoire, among the first to explore how sovereign debt can embed sustainability commitments into national policy, noted Jaquier.
Intersection of impact
Chile has been a frontrunner, according to Jaquier, having introduced its SLB framework in 2021, as well as setting out parameters for coupon step-ups and KPI selection. The initial issuance tied coupons to emissions reduction and renewable electricity targets. Since then, Chile has issued SLBs in multiple currencies with varying KPI mixes, adding gender equality in a framework update and more recently biodiversity. While the biodiversity KPI is now part of the framework, no bond has yet been issued against it, said Jaquier.
Speaking to Impact Investor, he said: “Chile introduced a biodiversity KPI, which is quite interesting. It targets an increase in protected areas, but also the effective management of existing ones, supported by national initiatives and policies. It’s a very interesting development and an important signal of commitment from sovereigns.”
Uruguay has also innovated its approach by tying its SLB framework to deforestation limits and commitments to increase forest cover in 2022. Meanwhile, Côte d’Ivoire has announced similar plans this year.
However, these instruments still present challenges. Green bond proceeds are earmarked for specific projects, making their use straightforward to track. In contrast to this, SLBs are linked to broader policy targets, which can make monitoring and verification more complex.
“There’s still a preference for labelled bonds where proceeds go to specific projects. With SLBs you don’t have that direct traceability, it’s more about aligning financial commitments with overall policy goals,” Jaquier noted. Furthermore, coupon step-up or step-down clauses (a feature in a bond that causes its interest rate to change at predetermined intervals or based on a specific event) add further complexity, as investors must judge long-term policy performance that is often hard to model in advance, he added.
This makes ongoing reporting critical. In Uruguay, for example, post-issuance disclosures showed that emissions actually rose, partly due to severe droughts between October 2022 and April 2023, he added. Jaquier said that while the outcome was not what was hoped for, it triggered positive actions which may not have happened otherwise such as bringing domestic attention to the emissions issue and prompting the government to create a cross-ministerial task force to understand what happened.
Looking ahead
For smaller economies in particular, SLBs can be more practical than traditional green bonds, which often require at least a billion dollars’ worth of projects to reach benchmark size, Jaquier said.
“For small economies, it can be difficult to find enough green projects to issue a benchmark-sized bond. SLBs can be a nice alternative, without needing to identify a billion dollars’ worth of projects on day one,” he added.
