Nobian and Public Power Corporation are at risk of missing performance targets for their sustainability-linked bonds (SLBs), which could prompt the first such “thematic default” for the European high-yield market, according to research by the Anthropocene Fixed Income Institute.
According to the non-profit boutique investment firm, data soon to be released by the two pioneering issuers of sub-investment-grade SLBs could provide valuable insight into how the market treats issuers that fall short of their sustainability performance targets (SPTs), and could lead to negative price action due to forced selling from ESG funds.
“Two high yield SLBs are expected to have missed their SPTs in December 2022, and the market waits both for confirmation but also for the investor reaction when it is confirmed,” Josephine Richardson, Anthropocene’s head of portfolio strategy wrote in a note published today. “As both are index-eligible, a thematic default could impact a wider range of investors than other SLBs we have observed.”
First issuer
Greece’s Public Power Corporation was the first issuer in the European high-yield space to adopt the now-standard sustainability-linked bond format, pricing a €650 million offering of 3.875% unsecured bonds in March 2021 to refinance debt.
The state-backed issuer, which is the largest power generation company in Greece and rated BB/BB-, at the time targeted a 40% reduction in the firm’s Scope 1 CO2 emissions by December 2022 versus the 2019 level, and told investors it would be achieved through the rapid phasing-out of its highly polluting lignite facilities. A coupon step-up of 50 bps is set to apply from 2023 if the company fails to meet the target.
Nobian, rated B/B2/B-, is the former industrial chemicals division of Nouryon, and priced its sustainability-linked bond in June 2021 with a €525 million offering of 3.625% secured notes maturing 2026 alongside a €1.09 billion term loan B to back the spin-off of its parent. The documentation here includes two key performance indicators (KPIs), the first linked to absolute Scope 1 and Scope 2 emissions reductions and the second to percentage use of energy from renewable sources. A coupon step-up of 12.5 bps applies for each KPI if the company fails to meet the targets by the end of 2022.
According to the report by Anthropocene, Nobian will need to reduce its absolute emissions by 12.1% for 2022 to achieve its first sustainability target, which the firm says is “very hard to achieve.” It does, however, look likely the company will achieve its second KPI linked to renewable energy, the report added.
A “default” by Nobian on its ESG target would have wider implications for the market than a miss by PPC, because 9% of the bond is held in ESG-labeled funds, compared to only 1% for PPC’s notes, Anthropocene said.
“[The] Nobian SLB seems to be more widely held in ESG-funds than PPC, and so we expect to watch the reaction in that bond with particular interest,” the report said. “If there were to be ‘forced selling’ from ESG-index funds, anticipation of this flow should form part of future SLB risk management around observation dates.”
Step-up penalty
The non-call three-year structure of PPC’s SLB means the step-up penalty for failing to meet targets will apply before the bond hits its first call in 2024. Nobian, on the other hand, has drawn investor criticism because the non-call two-year structure of its 2026 bond means the notes are callable before the penalty applies—effectively allowing the company to replace the bonds without incurring the sustainability-linked premium.
Surging interest rates since the deal was issued, however, means it is unlikely this would make economic sense for the company. While the bonds have climbed significantly from a record low of 75 in September, they are still well below their call price at around 87.
PPC’s 2026 bonds are meanwhile quoted around 93.5/96. The company also has a €500 million issue of sustainability-linked bonds maturing 2028, which it priced in July 2021 at 3.375%.
