Sustainability-Linked Bonds: The Next Frontier in Sustainable Finance?

[Umang Bhat Nair and Vedant Kashyap are fourth year BA. LL.B.(Hons.) students at the NALSAR University of Law, Hyderabad]

Earlier this year, India witnessed its first issue of a Sustainability-Linked Bond (‘SLB’) by UltraTech Cement. This is in line with India’s endeavour to achieve all of UN’s Sustainable Development Goals by 2030. India also wishes to achieve a robust 175 gigawatt of renewable energy capacity by 2022. In this vein, apart from development of ‘green projects’, there is also a need to make existing businesses more sustainable. However, such ambitious targets require intensive capital funding. The bond market allows companies to raise capital at fixed rates, which can be tapped into whenever needed. In addition, the ongoing pandemic has seen an increase in investor interest in companies taking part in sustainable financing initiatives such as SLBs and green bonds. This includes companies performing well on their environmental, social and governance (‘ESG’) targets given that such performances are in line with the ideal of a greener economy in the future. Hence, it is hardly surprising that in the first half of the current year alone, India raked in almost three times more of proceeds from sustainable financing than it did in its inaugural year in 2015.

Consequently, the authors argue that SLBs are the next frontier in sustainable finance. This article first introduces SLBs and briefly, green bonds (a more elaborate introduction to green bonds can be found here). Thereafter, given the recent introduction of SLBs in the Indian market, it will highlight the benefits and drawbacks of issuing SLBs, in comparison to green bonds. Finally, the authors make a comparative analysis on the bonds, in terms of how each strikes a balance between sustainable and commercial development.

Green and Sustainability-Linked Bonds: A Primer

India saw its first green bond issued in 2015 by Yes Bank. Today, India stands second in the world as the largest emerging green bond market. Simply put, green bonds are fixed-income instruments that are issued in support of climate or environment related projects. The proceeds from these instruments have to be mandatorily used for financing ‘green projects’ only. Some notable examples include the green bonds issued by JSW Hydro Energy, Adani Green Energy, and the Greenko Group.

SLBs, on the other hand, are like any other bond, with the only distinction being that their structural or financial characteristics vary, based on whether the issuer meets predefined Sustainability Performance Targets (‘SPT’). These targets are assessed by looking at whether the issuer achieves certain Key Performance Indicators (‘KPI’). SLBs allow the issuer to use the proceeds in any manner they deem fit and do not mandate use of proceeds (‘UoP’) for ‘green projects’ only. The caveat is that SLBs are forward-looking and performance-based, and therefore, may attract financial penalties on the issuers if they cannot meet their KPIs.

By way of illustration, consider UltraTech Cement’s SLB issue. The proceeds from the SLB are going to be used for non-green purposes, i.e., to refinance existing rupee-dominated debt, and pay for ongoing capital expenses and other general corporate requirements. For their SPT, UltraTech aims to reduce its carbon emissions by 22.2% by March 31, 2030. If they fail to meet this SPT, there shall be a financial penalty imposed on UltraTech by increasing the coupon, i.e., the interest payable on the bond, by 75 basis points, equivalent to 0.75%.

Having briefly explained the key characteristics of both bonds, the following section shall analyse the recent market phenomenon of SLBs by drawing comparisons to the more frequently used green bond.

Analysing SLBs Through the Lens of Green Bonds

The key difference between the two classes of bonds is the manner in which funds raised through both instruments can be utilized. It is this feature which defines both the benefits and drawbacks of issuing SLBs.


By allowing issuers to make use of proceeds for general purpose, SLBs permit corporations, which do not have a separate ‘green project’, to raise funds to improve their ESG performance. The ‘green’ tag that gets associated with the project leads to reputational gain for the company, and bolsters investor interest. By way of example, UltraTech Cement’s use of pro-environment SLBs provided an extra appeal to an otherwise carbon-intensive industry and resulted in a beneficial increase in the size of its deal.

Traditionally, green bond issuers heavily invest capital in ‘green’ projects. Several corporations that do not have such ‘green’ projects to seek investment in are precluded from raising green bonds. Now, with the more flexible issue of SLBs, corporations which were previously unable to access the green financing market due to the UoP restriction, can access the same. Companies engaged in undertakings with low ESG ratings can raise funds through SLBs and seek to make their existing businesses more sustainable. Accordingly, businesses as diverse as fashion brands and retailers are making use of SLBs. In this manner, the instrument is more inclusive than green bonds. In an environment where investor interest in ESG ratings translates into stock performance, this emerging instrument allows issuers to take care of shareholder interests. Companies which have had trouble increasing their stock prices owing to ESG considerations can make use of SLBs to improve their sustainability. Further, as we move from a shareholder-centric to a stakeholder-centric view, the introduction of a debt-instrument which can be availed of by non-green undertakings to deliver results in the interest of the latter is also beneficial.

The instrument, by providing for SPTs on select KPIs, also has a low compliance burden on issuers. Information related to performance on many of the KPIs that are required to be disclosed as part of SLB reporting, may already be a part of the issuer’s ESG disclosures under the Business Responsibility and Sustainability Report (‘BRSR’), which would be replacing the present Business Responsibility Report. For instance, in the case of UltraTech, information related to performance on the selected KPIs would need to be published as part of the BRSR.

The Sustainability-Linked Bond Principles (‘Principles’) published by the International Capital Market Association require the SPT to be ‘ambitious’. This means that the target must represent a material improvement in the KPI, based on a comparison with relevant benchmarks. For instance, in the case of UltraTech, a Second Party Opinion (‘SPO’) analysed the ambition of the SPT by making comparisons to the Company’s past performance as well as its industry peers. Such specified and quantifiable targets provide investors with a better and realistic understanding of the impact their investments will make. In contrast, any potential impact caused by investments in green bonds would only be accurately quantifiable upon completion of the green project. The project itself may take ages to complete or may even fail to materialise. In the face of such uncertainty, SLBs provide investors with a more certain quantification of their ‘green’ impact prior to investment itself.

These benefits make SLBs an attractive option for corporates and investors alike. However, at the same time, there are certain drawbacks which issuers must be aware of in order to accurately assess the suitability of the instrument to their purpose.


The flexibility in use of proceeds from SLBs puts a greater onus on the investors to make individual assessments of the materiality of the SPTs. While investors can be assured that their investment in Green Bonds is earmarked for utilization in ‘green projects’, there is no such assurance in case of SLBs. Additionally, the Principles do not prescribe an objective meaning to the term ‘ambition’. Consequently, it becomes important for investors to perform due diligence before investing in any SLB, otherwise they may inadvertently risk becoming a victim of greenwashing. This examination of SPTs may be as important to an impact investor seeking to make investments in ESG improvement, as credit quality is to an ordinary investor. Hence, any investment today in SLBs would require due diligence on part of the investor into the real ‘green’ impact the investment would facilitate.

There is also an ethical dilemma attached to the pay-offs for the bondholders in SLBs. The incentives for both parties, issuers and bondholders, is simple. The issuers pay a penalty, through a step-up in coupon, on failing to meet their sustainability targets. Thus, they have a financial incentive to improve their ESG performance. On the other hand, the bondholders stand to gain if the corporate fails to meet the selected targets. Such profit-making, in the event of non-fulfilment of SPTs, may present a dilemma for ESG-sensitive investors as, for them, there would be a non-alignment of ESG improvement and financial gain. For instance, a bondholder of UltraTech SLB will gain 75 basis points if the issuer fails to reduce its emissions to the agreed level. In comparison, holders of Green Bonds do not fall into such a dilemma, as proceeds from their investment are directly put into Green Projects, thus making a certain positive contribution to ‘green’ objectives. Hence, their financial incentive is positively linked to the ‘green project.’ Although such ethical considerations may be a matter of individual judgement, there is a need to flag this incentive-misalignment for the benefit of investors.


The post now circles back to the principal question: are SLBs the better bonds? While they help in meeting ESG targets by using SPTs and KPIs, there is an inherent contradiction in their penalty mechanism that cannot go unnoticed. On the other hand, impact investors that wish to make simpler direct contributions to ‘green’ goals are best suited opting for green bond. However, SLBs remain an important gateway for more issuers to tap into sustainable financing and improve their ‘green’ appeal. Looking at the exponential rise in issue of SLBs across the world, it is highly likely that India will also ride the wave. SLBs will allow smaller Indian companies to join this movement. It is hoped that sustainable financing soon becomes the primary source of financing in India.

Umang Bhat Nair and Vedant Kashyap

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