On another note, ING published a report this month calling for those working on sustainability-link loans and bonds to do more to uphold the integrity of these deals.

September Bond Issuance

The SLB hasn’t pleased every market participant. One of the main concerns surrounds Issuers freedom to choose their own KPIs and the performance targets set. Europcar's latest deal, although ahead of its peers, demonstrated these concerns. The €500m SLB issuance featured performance targets (SPTs) relating to carbon emissions and the ‘greenification’ of their fleet. However, we found these SPTs would have been completed in their normal course of business, and so do not necessarily show ‘advanced level of ambition’ the second party opinion provider claims.

The EU CO2 emissions regulation implemented mandatory requirements for new cars (95g CO2/km) and vans (144g) manufactured from the beginning of 2021. Therefore, if Europcar continues to maintain its average fleet age of 10-months, then the majority of its cars must be within this regulation by 2021/2022. This means the target set in 2024 is required by regulation and does not appear ambitious. The second SPT is also hardly advanced in nature. Europcar has set itself a target for its fleet to contain 20% of ‘green vehicles’ by 2024. However, as of 2026 the EU taxonomy will be adjusted to align to the Clean Vehicle Directive. Which in turn will align to the ‘fit for 55’ proposed EU law, stating that all new vehicles must be zero-emission by 2035. As such, the ambition of this SPT is questionable as it is merely in keeping proposed regulation (and will require a new target as of 2026).

Should second party opinion providers be doing a better job at critiquing these sustainable performance targets?

Europcar highlighted another concern amongst investors with regards to KPI testing dates. If the company misses both targets, to be tested in 2024, the coupon will step up by 25bps - so any coupon increases will only kick in from 2025. However, the notes mature in 2026, if not called at an earlier date - such as when they step down to par in October 2025. Although this is a standard format seen in SLB’s, the financial threat for a missed target is miniscule. Conversely, companies might argue that this allows the KPIs to be more ambitious and gives companies a few years in order to measure the progress towards achieving the KPIs.

Aside from investor concerns, Itelyum proved SLB’s are still being adapted. Instead of a coupon step-up, Itelyum’s bonds will pay a premium at maturity if the KPIs are not met. The €450m Senior Secured Notes call premium will increase by 0.3% if the issuer fails to meet one of its SPTs or by 0.6% if it fails to meet both of its SPTs. We noted in our legal analysis that the company could avoid paying the premium altogether by utilising; (i) the equity claw, (ii) 10% at 103 features, (iii) buying the bonds at open market prices or (iii) undertaking a tender offer below the specified redemption price.

Leveraged Loans: back with carbon black

After the typical August slumber, Green Leveraged Loans sustained their momentum with a strong September showing. Cumulative issuance now sits at ~€40bn YTD, demonstrating the speed at which the space has developed after seeing comparatively little action in 2020. September saw north of ~€4.5bn in fresh issuance, and aside from the sheer volume, some noteworthy novel terms were seen in market last month.

Of the Leveraged Loans with publicly disclosed sustainability linked terms, Roompot’s €1,050m TLB due 2028 is an obvious standout, listing the largest ratchet we have seen to date at +/- 15 bps based on three targets (greenhouse gas emissions, reduction of residual waste, and employee health and safety). The margin ratchets down if two targets are met, but ratchets up if none are met. As covered in our Roompot write up, Roompot is a rare example where the sustainability linked elements of the offering are material enough to be taken seriously by a large bulk investors, particularly in combination with the regular ratchet. One buysider noted “If that 450 bps goes down two steps on the regular ratchet, and there’s no way they are missing all ESG targets, then you’re really looking at a 385 bps deal, which isn’t particularly attractive or unattractive either way for a B2. It all adds up.” Given that the loan pricing eventually settled at 400 bps over Euribor, this point carries even more weight.

However, although a sizable ratchet certainly catches buysider attention with potential upside being eroded, from an ESG impact perspective, such terms are only as good as the ambition of the KPIs and SPTs attached to them. Unambitious targets save the issuer in interest payments, but obviously do little in terms of sustainability impact. One point in favour of Roompot is that all three KPIs are clearly measurable and avoid simple ‘disclosure’ performance indicators seen in other issuances (such as in Virgin Media-Ireland’s June offering which contained a KPI offering to “publicly announce” an ESG strategy).

Unfortunately in terms of the wider structuring of the sustainability terms, investors were more split. One noted that sponsor KKR were clearly “extremely conscious” to avoid greenwashing - a sign that the constant berating of lacklustre sustainability terms from sponsored issuers may be paying off? - with a two way ratchet kicking in on the downside if no targets are met. Others were hesitant to praise the ESG impact of the terms however, stating that the structure of the deal (to only penalise in the event of a miss on all three targets) is an issuer friendly structuring of the terms, as a full scale miss “isn’t going to happen”. This point holds merit, as the margin drops down if just two of three targets are hit, but ticks up only if all three targets are missed.

Elsewhere in the market, Orion also engineered their dual currency offering with ESG terms, although employing a more rudimentary +/- 10 bps ratchet linked to two KPIs, based around the SDG’s (Sustainable Development Goals). Even more mundane was Modulaire’s piecemeal approach to sustainability terminology in their €1.12bn LBO, offering a +/- 7.5 bps ratchet linked to scope one and two GHG emissions. Little to see here. Median Klinken’s €800m (equiv.) offering warrants a touch more interest however, with two industry relevant KPIs (based on quality of care) and an emissions KPI - following a similar KPI structure to that of Finnish care provider Mehilainen’s May 2021 TLB. Depending on the ambition of the SPT’s and the margin ratchet, this represents a reasonable debut step into the European SLL space for sponsor Waterland.

In the wider market

Elsewhere, MSCI’s chief Jorge Fernandez weighed in earlier this month with his views on the development of green finance, advocating for higher disclosure rather than prescriptive mandates on how companies should be rated from an ESG perspective (given the vast differences in how one can evaluate). Another note was to stress the importance of ‘E’ in ESG. In Fernandez’s words “climate is going to be much bigger than ESG”. In our LevFin focusing universe, this view sits opposed to buysiders who have expressed weariness at the prioritisation of the ‘E’ in ESG at the loss of ‘S’ and ‘G’ factors.

Carlyle continues to broaden their strong presence in the ESG space, not only via their portfolio companies but via linking its new €2.3bn RCF to ESG metrics. The facility (made available to the European private equity and real estate arm) is linked to the goal of 30% board diversity, better governance, and portfolio GHG emissions. This follows Intermediate Capital Group who in July closed a €1.45bn ESG linked subscription facility for its ICG Europe Fund VIII (dedicated to middle/upper middle European businesses), requiring portfolio companies to set emissions reduction targets aligned with the goals of the Paris Agreement.

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:

• O2 is under investigation by the Serious Fraud Office amid allegations of bribery following the £31bn merger between O2 and Virgin Media
• After being hit with a security breach last year, CMA CGM suffered another data leak this month. All of the world’s top container companies including Maersk, MSC and Cosco have experienced cyber attacks in the past year
• Clayton, Dubilier & Rice’s offshore bid vehicle, used to launch a £7bn takeover of Morisson has caused concerns over tax implications, after it was discovered that the vehicle was set up in the Cayman Islands
• BT faces a £600m compensation claim against them over allegations they overcharged more than two million landline customers

ESG QuickTakes

As part of 9fin's developing High Yield coverage, we will be producing more detailed ESG analysis for a number of credits. Please let us know your feedback so we can evaluate demand for ESG analysis and any suggested improvements. In the last month, we have published ESG QuickTakes on:

• Consolidated Energy
• Europcar
• Pasubio
• Solenis

If you would like to read one of our ESG QuickTakes, please complete your full details and we will email you a copy. Please note that we will only be able to respond to valid business emails.