In other areas of fixed income, World Bank issued its first wildlife bond, which could be better described as a ‘Rhino Bond’. The $150m issuance will pay returns determined by the rate of growth in population of rhinos in two South African reserves. To receive the maximum payment the rhino population will need to increase by more than 4% per annum. This landmark issue goes to show that there’s further creativeness yet to be unlocked in sustainability-linked bond issuance. We have tracked the continued development of sustainability-linked features in European high yield since inception and are now proud to present this data in our 9fin bond and loan screeners. If you are not a client but would like to see our screeners in action, please sign up here for a free trial.

PackESGing

One sustainability-linked deal, issued by US packaging firm Novolex, managed to slip through the net during this shutdown. The break in the market might be a turning point for ESG-linked issuance in the US, which only represented 4% of the overall HY market in 2021. In comparison, ~25% of the European market was “Green” in the same year.

The deal was split between secured and unsecured tranches, which had different sustainability adjustment mechanisms to one another. The secured’s had a 12.5 bps trigger attached to the redemption premium, whilst the unsecured’s penalty was attached to the bond coupon. Whilst this is a first in high yield, we saw different adjustments between tranches in Modulaire Group’s October 2021 issuance. In that deal the unsecureds had a lower coupon-step up of 25bps compared to the 30bps step-up attached to the secureds.

S&P, which has evaluated only a handful of SLB issuances, was employed to gauge the ambitiousness of Novolex’s sustainability performance target (SPT). As with the other Second Party Opinion (SPO) providers, S&P evaluated the target against ICMA’s Sustainability-Linked Bond Principles. The target was said to be aligned with the Principles but failed to show a strong or advanced level of ambition. As we point out in our ESG QuickTake, Scope 1 and 2 emissions only constitute 30% of the company’s total value chain emissions, meaning that the majority of emissions are not addressed by the SPT. The SPO provider also suggested that the group could have included more material sustainability issues, such as product circularity and waste reduction, which have been included in other packaging firms SPTs in the past (see below).

Packaging firms, who are under the constant microscope for their use of unsustainable materials, have been popular users of ESG-linked debt. In fact, packaging firms have collectively issued the second largest amount of ESG-linked debt in EHY after the Telecommunications industry. Increased consumer awareness of packaging waste in oceans and landfills is driving change and pushing firms into streamlining sustainability policies. With 41 Packaging firms currently active in European High Yield market, which one will be next?

We note Refresco, the Germany-based soft drinks bottler, did not include SPTs in its recent LBO transaction financing KKR’s purchase. In its defence, the firm has set a target for recycled PET (rPET) content of 50% by 2025, which matches Coca Cola’s global target. With market conditions as they are, it may not be the best idea to test the waters with an ESG-linked issuance. Immobiliare Grande Distrbuzione, an Italian Real Estate Developer, found this out the hard way after it was forced to postpone a Green Bond issue in late March.

Leveraged Loans

With weak primary showing signs of recovery after the prolonged break induced by the Russia-Ukraine crisis, sustainability linked issuance returned with some notable examples to dig into.

Prisa’s refinancing, agreed at end-March and totalling ~€1bn across four tranches, came with a notably tepid 3bps margin ratchet, linked to two KPIs that managed to be equally unimpressive: the creation and distribution of more content contributing to sustainable development, and the increase in advertising contribution to social and cultural institutions. The flimsiness of these KPIs is self explanatory, and another argument for an approach to ESG looking at the whole company rather than individual financing document mechanisms. This is illustrated on the buyside by increasingly expansive negative screens in ESG CLO docs, as we have covered. (If you are not a client but would like to request a copy, please click here). You can also keep up to date with the CLO market in our weekly Excess Spread newsletter.

Part of the supposed appeal of sustainability-linked instruments is that they are all inclusive, allowing even the most egregious of issuers to join in the fun as there are no bars on who can issue a sustainability-linked instrument - versus certain issuers being frozen out of ESG CLOs.

However, for the principle to work in practice, sustainability-linked instruments must come to market with a set of KPIs that demonstrate a meaningful improvement in the practices/business model of the issuer. With some €60bn (equiv.) of sustainability-linked leveraged loans now under our belt, it is telling that the few examples of such deals (highlighted in previous editions of the Junk) still stand out clearly in our minds. Hats off to EQT and Carlyle as two sponsors trying to use this structure to generate ESG impact across several of their deals over the past year, rather than drum up orders from green funds and/or save an additional 10 bps of interest when fluffy targets are met.

Spanish slate producer Cupa Group’s €480m LBO financing came with a market standard 7.5 bps ESG ratchet, linked to three KPIs. As we reported in our write up of the deal, management’s main claim here was on relative ESG performance - although slate mining is of course energy & raw material intensive, it has better ESG credentials than other building materials such as concrete from an emissions perspective. Several buysiders were unconvinced however, holding the view that Cupa’s “advantages over substitutes” do not make the company sustainable, as building product manufacturers are inherently heavy emitters and therefore weak ESG credits whichever way management try to frame it.

However, building products are and will continue to be necessary to basic economic activity, and until our homes are made out of mushroom (or other entirely biodegradable alternatives), analysing the relative ESG performance of existing materials is worthwhile. For example, although we were unable to verify Cupa’s claims surrounding the ESG performance of slate vs clay, slate certainly seems to perform better than concrete roofing solutions in emissions terms. If a higher utilisation of slate and other alternative roofing materials can move us away from dependence on concrete (the world’s third largest CO2 emitter) in the near term, then this is worthy of consideration.

An example of a highly industry specific approach to ESG is that taken in the structuring of negative screens in ESG CLOs. For example, relating to oil & gas/utility issuers, we saw as many as five product exclusions relating to this sector in ICG’s reset of ST Paul’s IX. Typical exclusions include 1% thermal coal, 10% oil, 50% gas and 0% nuclear (the apparent allergy towards nuclear in the docs is somewhat puzzling, from an emissions perspective).

Elsewhere, IFR reported that borrowers have approached banks targeting “suspiciously early” refinancing, in an apparent move to reset the test dates on their SLL tranches. With the article referencing a “handful of [undisclosed] borrowers” and stating that issuers are looking to refinance with the purpose of avoiding as little as a 2bp ratchet step up (in the event of missing one specific KPI for example), we find this quite difficult to comprehend. Refinancing well-priced debt early into a bearish climate steeped in geopolitical and cyclical risk, with the primary purpose of sidestepping a 2bp ratchet would be, we think, unwise.

However, the article prompted us to think more broadly about the phrasing of these clauses in particular - a more ESG-friendly structuring in future could include a mechanism to carry test dates across docs of future debt offerings.

Selected 9fin ESG Highlights

9fin’s ESG filter  has brought to light some important social and governance-related news from the previous month which are worth highlighting:

• The biomass industry, including Drax, has objected to classifying some forest areas as ‘no go’ for harvesting trees. The European Commission has proposed new regulation that states that wood fuel from valuable ecosystems should not be classified as renewables
  
• A leader of an indigenous group staged a protest to highlight alleged damage Smufit Kappa’s business operations were causing to the environment in the Cauca region of Colombia
  
• Retirement home operator Orpea, faces allegations of mistreatment of elderly patients. The probe, which opened in February, for alleged falsification of records and violation of labour rules has now be widened following referral by the French government
  
• CEO remuneration has been in the spotlight recently, with Virgin Media O2 CEO paid $62m in 2021, considerably more than rivals. Investors were also concerned over the Ocado CEO’s £20m-a-year bonus plan
  
• According to environmental groups, Brazilian-based meat packer JBS released 421.6 million metric tonnes of carbon in 2021, a larger footprint than all of Italy and almost as large as that of the UK. The company reportedly has increased emissions by 51% since 2016 despite having a net zero pledge by 2040
  
• Adler Group continues to be plagued by concerns regarding the validity of its accounts, as we extensively covered

ESG QuickTakes & Primers

9fin produces ESG QuickTakes on all new issuance. Our fast and focused reports get you up to speed on everything you need to know about a credit and what ESG factors are material to it. If you are not a client but would like to request a copy of any of our recent reports, please click on the link and complete your details.

• Miller Homes - ESG QuickTake (9fin)
• Refresco - ESG QuickTake (9fin)
• Fortescue Metals Group ESG QuickTake (9fin)
• Novolex - ESG QuickTake (9fin)
• Citrix - ESG QuickTake (9fin)

You can also read some of our ESG features here:

• The employee strikes back! (9fin)
• The SEC Climate Disclosures Proposal (9fin)

Or request a copy of

• Mutually Assured Construction (9fin)

If you would like to know more about the market-leading ESG instrument data that can be found on 9fin, please click here.