The Sustainability-Linked Bond (SLB) market has experienced strong expansion in recent years, reaching 135 billion dollars in outstanding securities in 2021, with an additional 46.6 billion dollars cumulative during the first half of 2022 according to Climate Bonds Initiative (CBI).

SLB bonds are forward-looking instruments in which issuers pre-determine sustainability performance targets and key performance indicators to measure over time, including financial penalties if targets are not met after a pre-agreed time.

According to a recent IDB Invest blog post, SLB bonds are an important tool to foster desired results, but incentives can also have unintended negative consequences if poorly crafted. To address potential deficiencies, the Emerging Markets Investors Alliance (“EMIA”) has published its second edition of the “Enhanced Labeled Bond Principles” to promote the development of labeled bonds and SLBs that allow for a significant contribution toward incorporating Environmental, Social and Governance factors (ESG). Entities such as IDB Invest are also working to incorporate best practices and mitigating actions into their investment market to address potential SLB bond deficiencies and establish better benchmarks.

The authors finally remark that beyond the known reputational risk of “green-washing”, other points of attention regarding the integrity of the SLB bond market can be grouped into three main areas: (a) Insufficiently robust and ambitious objectives and metrics; (b) Improperly crafted incentives; and (c) Structural loopholes.