The Price of Green Commitments: A Study of Pricing Mechanisms of Sustainability-linked Bonds

Abstract

With the call for climate action reaching unprecedented levels, bond markets have introduced a tool with remarkable potential. The new Sustainability-Linked Bond (SLB) type emphasize the premise of sustainable accountability in a contractual conditionality linking borrowing costs to green commitments. Given its recent market introduction, the SLB bond type represents a narrow space of sustainable finance academia with literature yet to fully contextualize its pricing mechanisms and features. Using a strict matching principle, this study finds a significant credit spread premium between SLBs and conventional bonds of -24 bps, implying a substantial borrowing cost advantage for issuers in the primary market. Main model testing suggests this premium to widen to -26.59 bps for corporate non-financial issuers when adjusted for in-match deltas on common sources of yield differential. This implies that investors are willing to accept lower spreads in return for sustainable accountability. Yet, in their current form, SLBs have been criticized as a greenwashing loophole for issuers compromising ambition and impact materiality. Addressing such, this study challenges the notion that a borrowing cost advantage is available to issuers unconditionally of how they design their frameworks. Instead, evidence suggests that issuers benefit if their SLBs possess shorter maturities, high credit ratings, and third-party verification of target alignment. Contrary, the premium is tightened for callable SLBs with the acknowledgment that it loosens the fundamental link between financing and sustainability. Further, the study finds that issuers with ESG scores in the best quartile might enjoy a more substantial premium, while aboveaverage scores on any of the individual E, S, or G parameters do not seem to carry a significant premia contribution. Extending the analytical basis of previous primary market studies, this paper contributes to the developing consensus on systematic pricing differences while highlighting the relevance of future research targeting subsequent market price reactions and volatility patterns.