Sustainability-Linked Bonds Phiroza Katrak pkatrak@arlingclose.com

In April, in a global first for banking, German lender Berlin Hyp issued a €500 million sustainability-linked bond (SLB) which directly links the bond coupon to the bank achieving its climate and sustainability targets. 

The coupon on this 10-year senior unsecured preferred bond is 0.375% and is linked to the bank achieving a 40% reduction in CO2 across its entire loan portfolio between by 2030 compared to the figure in 2020 and, by doing so, the bank also directly aligns itself to the Paris Agreement’s climate targets.  The bond’s coupon will increase by 0.25% in its final year if Berlin Hyp fails to reduce the carbon intensity of its loan portfolio.

German lenders have been Europe’s stalwarts of green bond issuance and Berlin Hyp is a seasoned green bond issuer; the bank also issued a green covered bond in 2015. It is a mortgage bank offering real estate finance mainly for commercial and residential properties.  Real estate is one of the biggest emitters of CO2, not just in Europe, but worldwide. Failure to meet its sustainability target would not only trigger the step-up in the coupon, increasing the bank’s cost of capital, but would also have reputational repercussions for the institution which mostly refinances through the capital markets.

Linking the bond coupon to achieving an ambitious reduction in carbon intensity across the bank’s entire loan book and within a 10-year timeframe is, therefore, a bold move and a challenge for other financial institutions to emulate. 

Measuring banks’ ESG metrics and impact are more complex than those for non-financial institutions, not least the aggregation of information across varying borrowers and diverse ESG reporting systems. It takes a comprehensive database of borrowers’ carbon emissions and a robust and reliable climate risk management framework to be confident in delivering a quantifiable carbon footprint reduction within a prescribed time horizon. Berlin Hyp’s methodology of calculating the rate of CO2 reduction for this bond’s KPI has been validated by Sustainalytics, an independent ESG ratings company.

The bond is rated Aa2 by Moody’s and AA- by Fitch.

How successful was the issuance? Orders of nearly €1 billion were placed.  The innovative deal has set a high bar for meaningful ESG targets and approaches to sustainability.