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Policy Performance Bonds aka Sovereign Sustainability‑Linked Bonds

Sovereign sustainability-linked bonds (SSLBs) are a simple, and somewhat subversive idea introduced by Z/Yen in 2005 as part of discussions during the formation of the London Accord. The wider concept of government bonds providing financial indemnity to investors is termed Policy Performance Bonds, of which SSLBs are a subset.

A SSLB is a government issued bond where, in its simplest form, interest payments are linked to sustainability policy goals. For example, a SSLB might pay higher interest if the greenhouse gas emissions of the issuing country were higher than published targets. An investor in such a bond receives an excess return if the issuing country’s emissions are above the government’s published target. SSLBs are analogous to an inflation-linked bond where the interest paid goes up if inflation rises.

A SSLB thus provides a hedge against the issuing country’s government not delivering on its commitments or targets. SSLBs can be issued against carbon emissions reduction targets but also forest preservation targets and any other area where policy risk is significant. The ability to hedge enables more confident investment in projects or technologies that pay off in a low-carbon future because if the low-carbon future fails to arrive the government too bears direct costs of having to pay higher interest rates on government debt. Index-linked carbon bonds eliminate the one risk that differentiates clean tech projects from other energy projects, the uncertainty of government policy actually being directed at a low carbon future.

One important point – the monies raised for the government do not have to be used on ‘green’ projects; the monies can be used for schools, roads, or policing. As with inflation, how the government gets inflation down is its own problem; same here, how the government reduces emissions is its own problem – just meet the target(s).

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Corporate sustainability-linked bonds (CSLBs), also known as performance incentive bonds or policy performance bonds, started being issued in 2017 due to informal sponsorship of the idea by the French government by the Prime Minister's think-tank during COP21 in Paris in 2015. The sustainability-linked bond sector has grown rapidly to become a significant portion of the wider 'green bond' market. Notable early issuers were Danone, Louis Dreyfus, and ENEL.

However, Z/Yen's ultimate objective was directed towards governments in order to reduce political risk in green investments in infrastructure and energy. The first government issue was a $2bn issue in Chile in March 2022, followed by Uruguay in October 2022. Both countries have issued more since 2022, and were joined by Thailand in November 2024 with its first issue. The effect in both Chile and Uruguay has been to increase the attractiveness of green investments by providing a ‘hedge’ on policy risk, to reduce the attractiveness of fossil fuel investments, and to accelerate both countries green transformation projects.

A variety of targets can be used to set the interest rate, such as levels of greenhouse gas emissions, percentage of renewable energy in overall energy supply, minimum prices of emission certificates in a trading system, or levels of taxes on fossil fuels or fossil fuel end-user prices. In the case of Chile, the bond was a 20 year bond with two KPIs:

  • an absolute reduction in greenhouse gas emissions (from 112.3mt/pa in 2018 to 95mt/pa by 2030);
  • an increase in renewable energy generation (60% from renewables by 2032).

The same idea can be used for forestry bonds on forestry cover, water quality, and other sustainability policies. Since first mooted by Long Finance and the London Accord (Z/Yen first published in April 2009, and policy performance bonds were formally presented outside Z/Yen by Dr Kevin Parker at the World Bank Government Borrowers' Forum in Ljubljana in May 2009), in 2017 the private sector began issuing these bonds, tying interest rates inversely to performance against the achievement of environmental, social, or governance goals (as opposed to saying the proceeds will be used for ESG purposes). The terms "sustainability-linked finance" or "positive incentive loan" are sometimes used. An informal table of significant issues includes:

A series of bond 'flavours' seem to be emerging, in increasing order of earnestness:

  • green (claim that proceeds will be used for green projects);
  • sustainability or ESG (claim that proceeds will be used for wider ESG goals);
  • sustainability or ESG where the issuer will report directly on the target(s), e.g. Alphabet/Google's US$5.75 billion (2020) issue will report on progress of project investments in energy efficiency, renewable energy, green buildings, clean transport, circular economy & design, affordable housing, racial equality, and support for small businesses in the wake of Covid-19;
  • policy performance bonds – where the issuer puts its money where its mouth is, i.e. interest payments are linked to achievement.

We are delighted with the help we got in France to push the idea among French and Continental corporates. We're particularly pleased with Chile, but also rapid market growth:

"Global sales of sustainability-linked bonds, a subset of ESG debt, hit a record $110 billion last year, compared with $11 billion issued in 2020, according to data compiled by Bloomberg. Moody’s ESG Solutions expects issuance of the debt to hit $150 billion this year."

Bloomberg (22 February 2022)

So, which other governments are prepared to put monies where their policy mouths are?

We were delighted that Vanessa Havard-Williams put sovereign-sustainability linked bonds in her October 2024 transition finance market review, "Scaling Transition Finance: Findings of the Transition Finance Market Review" - see page 101 and also search on Chile and Uruguay. Only twinge is no mention of your or Z/Yen’s work on this since 2006. Important thing is it’s finally scoring thoughts in the UK.

All best wishes,

Michael

Related Reports:

https://www.longfinance.net/media/documents/policy_performance_bond_supplement_1.3_SM_220506.pdf

Sovereign Sustainability-Linked Bonds: Chile Sets A High Bar - This supplement to the ninth edition of the Global Green Finance Index takes as it subject green-bonds, a product which has been credited with turbo-charging the green finance revolution. In this report we examine the lessons learned by Chile in the development of a new type of green bond — sovereign sustainability-linked bonds (aka policy performance bonds), which are likely to have a significant impact on sovereign debt markets as other nations join Chile to deliver sustainable growth.

An even briefer two page summary is here:


Related Books:

InnovationFin

L’Innovation Financière Au Service Du Climat: Les Obligations Á Impact Environnemental

by Abdeldjellil Bouzidi & Michael Mainelli,

ISBN 978-2-86-325784-5

February 2017




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