Emerging-Market Banks Looking at Sustainability-Linked Bonds, HSBC Says

(Bloomberg) -- Banks in developing nations are looking at a new bond type as a way into the booming socially responsible debt market, according to HSBC Holdings Plc.

So-called sustainability-linked bonds may suit emerging-market lenders because they sidestep challenges found in green and social notes, said Farnam Bidgoli, head of sustainable bonds at HSBC. In particular, lenders only have to focus on their own activities rather than scrutinizing whether clients' use of bank loans meets the eligibility requirements of the traditional bonds.

“We've seen a lot of interest in the structure, especially from the emerging markets,” said Bidgoli. “I'm sure we'll see banks do them.”

Issuers of the new types of notes pledge to pay a penalty if they miss companywide ESG targets, which for banks could include reducing fossil-fuel financing, boosting loans in disadvantaged regions or raising female management levels. That could open the lower-cost ethical debt sector to emerging-market lenders, which presently account for less than 5% of global green and social bank bonds, excluding China, according to data compiled by Bloomberg.

Lenders worldwide are yet to enter the nascent sustainability-linked bond market, with the concept instead being led by corporate borrowers including Enel SpA, Novartis SA and Chanel. International Capital Markets Association, an industry group, published principles for the bonds earlier this year to help drive further development. Issuers can use funds from the bonds for whatever they like. That contrasts with green-bond proceeds, which can only be used for environmental projects.

READ MORE: ECB, Chanel Bolster Tiny Bond Market That Rewards Doing Good

Bank bail-in regulations may be an issue for lenders considering the notes, as coupon step-ups are prohibited in bonds issued to absorb losses in a crisis. Still, Chanel's deal last month offers a potential alternative model as the fashion house will pay a higher principal rather than a higher coupon if it misses targets. Banks could alternatively issue debt not covered by the bail-in rules, such as senior preferred notes.

The range of possible of ESG targets also means that issuers can look beyond environmental topics and focus on challenges that are most relevant to them, said Nicholas Pfaff, head of sustainable finance at International Capital Markets Association.

“The beauty of this new product is the flexibility,” Pfaff said. Still, “it does require a significant amount of thinking, planning and top management buy-in,” he said.

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