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Alice Holian

With the market for ESG financial products burgeoning, it is no surprise that issuers are becoming creative in linking their bonds’ financial and/or structural characteristics to their sustainability targets. Today (13 September 2021) marks the launch of a €450 million sustainability-linked bond offering to finance Stirling Square’s acquisition of Itelyum, an Italian waste management company. The bonds feature a novel sustainability-linked redemption premium step-up, which is new to the European high yield market.

As the market kicks back into full swing after a quiet August, global issuance of Sustainability-Linked Bonds (‘SLBs’) continues to reach new heights with the cumulative issuance standing at a monstrous €20.1bn year-to-date compared to 2020 where just ~€2.7bn was recorded across the European markets, as dissected further in 9fin’s monthly Sustainable Junk.

Typically, SLBs feature a coupon step-up mechanism - i.e. if the issuer fails to meet its sustainability performance targets, the interest rate payable rises. This stands in contrast to sustainability-linked leveraged loans, which typically feature a two-way margin ratchet (with the margin reducing if certain KPIs are met and a corresponding margin increase if not). Bonds, however, usually only include a one-way interest step-up mechanism, with the bond interest rate increasing if the issuer fails to meet their sustainability performance target. Picard and Public Power Corporation are two examples from July where the bond included a coupon step-up mechanism.

In these deals, if a coupon step-up applies, then it also has a knock-on effect on the premia that would apply for redemptions under the bond’s call schedule, which are typically set as a percentage of the coupon (i.e., par + 50% coupon, 25%, etc…), as well as the premia for make-whole redemptions.

In contrast, the step-up mechanism in Itelyum’s LBO bond applies only to redemption premia, without any corresponding increase in the interest rate payable on the bond. In other words, even if Itelyum’s sustainability performance targets are not met, the issuer can continue to pay the same interest rate on the bonds. The step-up will only be triggered if the issuer opts to redeem some or all of the bonds — and then only in certain cases.

The step-ups will apply to redemptions under the make-whole, optional redemption and redemption at maturity provisions on or after 30 June 2022 (the expected publication date for the 2021 sustainability report), but not redemptions under the equity claw (premium typically set at par + coupon) or the 10% at 103 provision.

The applicable call premium will increase by 0.3% if the issuer fails to meet one of its sustainability performance targets or by 0.6% if it fails to meet both of its sustainability performance targets. The sustainability performance targets relate to the percentage increase in CO2 avoided emissions and the quantity of waste collected and delivered to circular treatment, in each case, as compared to a FY2020 baseline, as described in more detail in our Legals Quicktake.

The effect of the call premium step-up seems much less onerous on the issuer than an interest rate step-up, as redemptions are one-off events where the issuer can control the timing. The issuer could hold off on redeeming the bonds during periods when the targets are not met and suffer no financial penalty. In addition, the premium would only be payable on the portion of the bonds being redeemed, as opposed to a coupon step-up, which would be payable on the entire principal amount outstanding.

Moreover, the issuer could avoid paying the premium altogether by utilising the equity claw and/or 10% at 103 features, by buying up bonds at open market prices or undertaking a tender offer below the specified redemption price.

On the other hand, we note that the max 60 bps premium step-up is a sizable adjustment relative to the coupon step-up adjustments we have been seeing, which have typically maxed out around 25 bps (50 bps in Public Power Corporation).

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