Sustainability-Linked Bonds: The Next Frontier in Sovereign Financing

Abstract

Sustainable finance emerged as a key trend in the debt finance markets in recent years. In 2019 and 2020, debtors were issuing so called “green,” “social” and “sustainable” (GSS) bonds in unprecedented amounts, and sovereigns were no exception. 2019 also saw the inaugural issuance of a sustainability-linked or key performance indicator (KPI) bond, and this new instrument became a more and more frequent feature of the corporate sustainable debt markets in 2020. As sovereigns look to future sustainable debt offerings, they are well-positioned to issue KPI bonds and take advantage of some of their key benefits. This article describes the main characteristics of GSS bonds and the evolution of the sovereign GSS bond market to date. It then looks at KPI bond issuance trends and describes how this new instrument works. Finally, this article analyzes potential risks and structural considerations for sovereigns tied to KPI bond issuances, including: (i) which indicators to select, (ii) at what level to set the target, and (iii) how to create a framework for a credible and market-accepted verification of their performance.