14 June 2022

Why Enel turned to sustainability-linked bonds

After kick-starting the sustainability-linked bond market in 2019, the Italian firm continues to drive interest in the fast-growing market. Ahren Lester reports

Energy infrastructure firm Enel's ground-breaking UN Sustainable Development Goal (SDG)-linked bond came a year before the market adopted the sustainability-linked bond structure wholeheartedly.

When Enel issued its $1.5 billion SDG-linked bond in September 2019, the Italian firm was not a newcomer to the sustainable bond market. Prior to this deal, according to Environmental Finance Data, it had raised €3.5 billion ($3.7 billion) in total from green bonds since its first issue in 2017. Since then, however, Enel has raised more than $24 billion from sustainability-linked bonds (SLBs) in three currencies – making it by far the largest issuer of the instrument to date.

Although still a fan of the use-of-proceeds green bond structure (see Box: Enel still a fan of green bonds – but not sustainability-linked green bonds), Enel finance and insurance head Alessandro Canta told Environmental Finance the company hit upon the SDG-linked bond idea after realising that it was essentially "doubling" its work by issuing green-labelled notes.

"We realised that we, basically, were doing the same thing on one side, on the overall strategy of the company – because every single investment decision that went to the investment committee had to respect our [company-wide] strategy decarbonisation KPI [key performance indicator]. And we were then, basically, doing the same job on a subset of projects [to issue a green bond]. So, we realised what we were doing is basically doubling up all the activity."

As a result, Canta said it was neither better for Enel nor more convenient for its investors to present a subset of its strategy through a green bond, than a bond that was linked to targets reflective of the overall strategy through the SDG-linked bond structure.

'Not easy'

Despite Enel hoping the performance-based instrument would ultimately reduce its work in linking its financing to its transition strategy, building the novel SDG-linked bond from scratch proved a "fairly challenging" process for the company.

Canta said the process of getting the SDG-linked instrument off the ground – which was started immediately after it issued its last green bond in January 2019 – was "not easy".

First, it had to get the entire company on board with the process – from the management teams of the renewable energy, conventional generation and infrastructure network businesses, as well as the energy services unit. Once they were able to convince themselves internally that it was a good idea, however, they then leveraged their relations with investors to discuss the idea in several roadshows throughout 2019.

Enel initially targeted US investors through its maiden $1.5 billion SDG-linked bond in September 2019, as the US market was a sustainable finance 'greenfield' compared with Europe, Canta said. This was because US investors were not as familiar with the use-of-proceeds green, social and sustainability bonds as their European peers.

Enel still a fan of green bonds – but not sustainability-linked green bonds

Although Enel has committed to only financing through SLBs in the future, Canta is keen to emphasise that Enel remains a fan of the green bond – especially for those companies earlier in the process of developing their transition strategy.

"Not all companies are ready to utilise KPIs," he said. "If you are a company that still does not have specific KPI, we encourage them to utilise the use-of-proceeds format because they are contributing to their transition. And, most likely, those companies are the most polluting ones and we need them to really make an effort."

Nonetheless, he is not convinced that the combination of the performance-based and use-of-proceeds structure through sustainability-linked green bonds is a good innovation for the market.

"The combination of the two – the use of proceeds with sustainability linked features – does not make a lot of sense," he said.

With an SLB, he said, "you are already investing in a strategy – and the projects are part of the strategy. So, why do you have to also commit on the use-of-proceeds? It is a little bit confusing."

"This is why we started in the US," he said. "We wanted to deliver our argument to serious investors with an open mind to the product. Investors who were starting to move towards sustainable finance – so they were eager to invest in sustainable finance – but they were not already preferring certain sustainable bond products over others."

Enel had built a strong sustainability track record since its updated strategy in 2014, with reporting on progress towards decarbonisation targets improving each year. Yet Enel still found investors were not immediately taken by plans to depart from the tried-and-trusted green bond structure. Indeed, discussions with investors were "challenging" at the beginning of the investor roadshows.

Nonetheless, after these discussions investors were not only keen to invest in the new bond but also publicly promote their role as major investors on the deal.

Sustainability is a 'one-notch upgrade'

The SLBs issued by Enel have resulted in what Canta described as a "sensible" discount to the cost of the bond, of between 10% to 15% of the total coupon. In the low interest rate environment in which its issuances have currently been delivered, this may not currently translate into a huge basis point reduction in the coupon.

Nonetheless, Canta said that, as interest rates rise, this discount could become more significant.

"Sustainability is value – if you are serious and you are sustainable, you can get a discount"

"If we are able to issue regularly with a certain discount, we are implicitly saying that we have – thanks to our sustainability strategy – a one notch upgrade in our credit rating," he said. "That is because we are issuing at the cost of an 'A'-rated company rather than a 'BBB'-rated company – because this is the differential that is now in the market between a solid BBB company and an A company."

"We would like to demonstrate to the credit rating agencies that we already deserve a better rating due to the fact that we are sustainable, and implicitly this instrument is contributing to that," he said.

'Positively surprised'

Canta said Enel has been "positively surprised" by the extent to which SLBs have been adopted by the market since the bond market restarted following the initial uncertainty wrought by the Covid-19 pandemic.

"After the success of our dollar and euro SDG-linked bonds, the Covid-19 pandemic effectively put a stop to the capital markets," he said. "But, when the market reopened at the end of 2020, we have been positively surprised by the fact that other companies started to issue the same product."

The instrument also benefitted from the Sustainability-Linked Bond Principles being published by the International Capital Market Association (ICMA) in June 2020 and the "important blessing" from the European Central Bank in September 2020.

The SLB structure also points to two "very important ideas", Canta said. The first is that "sustainability is value" by demonstrating that a sustainable company is more resilient and more profitable. This, he said, was reflected in the discount – or 'greenium' – that the SLBs issued by Enel have attracted. He said the initial bond secured a "significant" discount, but subsequent issuances have secured a "substantial" discount.

"Sustainability is value – if you are serious and you are sustainable, you can get a discount," he said. "This is an economic incentive that may push a lot of companies to accelerate the process of transition."

His second point is that SLBs generate "positive behaviour inside companies".

A key boost to the sustainable bond market would be the extensive issuance by governments to set a benchmark for the market.

But, another key element to help issuers such as Enel utilise sustainable bonds more significantly in the future is clarity from investors on "how much they are ready to invest in sustainable bonds".

Some investors specify which funds exclusively invest in sustainable bonds, or provide guidance on what proportion of some of their funds are invested in sustainable bonds – but many still do not disclose how willing they are to invest in sustainable bonds, leaving a degree of uncertainty as to the level of demand. This situation has been improving in the last year or so, according to Canta, but a "clear statement" from investors about their level of interest would be "welcome" for issuers.

SLBs – a tool for scaling sustainable investment?

"Another very interesting argument that we have leveraged whilst talking with investors is that now they are heavily invested in perhaps 100 green bonds," Canta said. "But, what is going to happen when you want to be invested in 1,000 or 10,000 green bonds? You would have to hire 30 people just in order to track every single data point coming from the use of proceeds instrument."

In other words, the administrative task of verifying the ongoing 'greenness' of the bond investments would be immense. This potentially could become evident with the EU coming to the green bond market this year.

With the huge sums expected to be involved in this green bond issuance programme, Canta said, "it will be big trouble and a mess to try to reconciliate all the data on the use of proceeds because we are speaking of a huge quantity of projects".

But, what is more, you also risk missing the progress towards overall decarbonisation and sustainability progress.

"Let us give Enel as an example," he said. "If we continued to issue under the use of proceeds scheme, we would have proposed to investors a subset of our strategy. But, the investors may have missed the bigger picture. So, they are investing in these things [through the Enel bond], but are they sure that the combination of these investments is putting Enel on course to respect the 1.5֯C scenario target? You don't have this evidence."

Consequently, Canta said Enel has been using this argument in its discussions with the European Commission and he hopes it will consider SLBs as part of its sustainable bond issuance programme – especially as they already have clear climate targets in place.

More broadly, Canta said he was "excited" that Chile became the first sovereign to issue a SLB in March. He said this was a "courageous" step for the country and is an "important milestone" for the SLB product – and a trend he hopes other sovereigns will chose to pursue in the future.

"With the entry into the field of sovereign issuers, the fight to achieve ambitious sustainability goals is strengthened and now relies on a double push: one from the private sector and one from the public sector," he said. "It is a synergy that can significantly foster sustainable development and accelerate the achievement of global sustainability goals."

Credit rating agencies

Canta would also like to see greater recognition of sustainability metrics by credit rating agencies (CRAs). He hopes that, over time, CRAs integrate sustainability metrics into their existing credit assessment metrics so that any upgrade or downgrade reflects on how much the business is sustainable.

However, he emphasised that he was "not complaining" that CRAs had yet to integrate this into their credit analysis.

"Probably they are waiting to make this step in order to let this market mature a bit, because you forget that sustainable finance is still only 4% or 5% of the global capital market," he said.

"But now the market is maturing," he said. "And so, most likely, the rating agencies will feel from the market itself that they need to integrate the two sides of the same coin – the financial and sustainable."

For example, Canta said it has proven "quite difficult" for CRAs to develop a framework that integrates sustainable metrics into financial metrics. But CRAs have been investing heavily in this – including through acquisitions – and issuers are increasingly looking to deliver a coherent message between their financial and sustainability reporting.

In the past, Canta said, some companies did not provide much coherence even in financial reporting – presenting to equity shareholders a certain story, but to bondholders the same overall story but from a different angle. The market has now moved away from this disjointed financial reporting and he hopes this can be replicated in the way companies present financial and sustainability reporting in the future.

For Enel's part, it has already made significant steps in integrating non-financial sustainability disclosures with its financial disclosures in its own reports, he claimed. Looking at its 2020 and 2021 annual reports, an investor is greeted in the performance section first with key sustainability indicators – such as carbon emissions, water use, capital expenditure share for low-carbon investment – before reaching the familiar financial details of revenue and profit a couple of pages later.

"This has contributed positively because we are presenting to investors the concept that you can find not only the track record of our financials – which are important – but also the track record of what we are doing on sustainability in only one document," he said.

It is not possible, according to Canta, to keep the financial and sustainability stories of a company separate. Consequently, Canta said it "does not make any sense" to have separate sustainability rating and credit rating.

Indeed, he said there are "too many" ESG rating agencies and they are still not transparent enough. Canta said in recent years CRAs have improved disclosure of their model so that market participants can understand about 80% of the model and get a "good reading" of how CRAs will rate you, but this is "not the case" for ESG rating agencies – although some are more "open" about their model than others.

Enel's evolving sustainability performance targets

After initially setting a simple target for its maiden sustainability-linked bond, Enel has adopted increasingly advanced and extensive sustainability performance targets (SPTs) for its SLBs – with further developments in the pipeline.

For the initial SDG-linked bond in 2019, Enel set a target to increase its total share of installed renewable capacity to 55% of total capacity by the end of 2021.

At its update in October 2020, it had added a 2022 target of 60% renewable capacity as well as introducing a 2030 target related to reducing Scope 1 greenhouse gas (GHG) emissions intensity to 125 grammes of CO2 per kWh (gCO2/kWh).

By January 2022, however, the firm has updated it framework again, with more ambitious targets and intermediate trigger events in line with achieving net-zero Scope 1 emissions and for its installed capacity to be entirely from renewables by 2040.

Enel SPTs (as of January 2022)

 20222023 2024 2030 2040
GHG Intensity (gCO2/kWh)  n/a  148 140 82 0
Renewable Capacity (share) 60%  65% 66% 80% 100%

In the future, Canta told Environmental Finance the firm will consider adding additional key performance indicators (KPIs) for its SLBs. The company is also looking to get all its net-zero targets – including Scope 1, 2 and 3 emissions – verified by the Science Based Targets initiative (SBTi).

"As soon as practicable, Enel will be asking the SBTi to certify all its net zero targets across all scopes as aligned to the 1.5°C scenario according to the SBTi's Net Zero Standard released in the last quarter of 2021," he said