Green and Sustainability-Linked Bonds

Two bonds can both be marketed as environmentally friendly and work in completely different ways. A green bond is an ordinary bond whose proceeds are earmarked for specific environmental projects — the promise is about where the money goes. A sustainability-linked bond (SLB) doesn't restrict spending at all; instead its coupon rate itself changes depending on whether the issuer hits a stated sustainability target — the promise is about what the issuer achieves. Confusing the two means missing where the actual legal teeth are.

Two structures, two enforcement mechanisms

A green bond is structured, priced, and repaid exactly like any ordinary bond of the same maturity and credit quality — same coupon mechanics, same seniority — except the issuer commits (usually via a framework aligned with recognized principles, verified by an external reviewer) to spend proceeds only on eligible green projects, like renewable energy or efficient buildings, and to report periodically on how the money was used. There is no bond-terms penalty if the issuer fails to spend appropriately — the consequence is reputational and, potentially, exclusion from green bond indices going forward.

An SLB, by contrast, is not tied to how proceeds are used at all — the money can go to general corporate purposes. Instead, the bond's coupon includes a step-up (or step-down) clause tied to whether the issuer achieves a specific, measurable sustainability performance target by a stated date, verified by an independent party.

Worked example

A company issues a 7-year SLB with an initial coupon of 4.50% and a target of cutting its scope 1 and 2 carbon emissions by 30% versus a baseline year, verified by an independent auditor at year 5, with a 25 basis point step-up if the target is missed.

1. At issuance, investors receive 4.50% annually, same as an equivalent conventional bond might yield, sometimes slightly lower if investor demand for the sustainability feature is strong (a "greenium").
2. At year 5, the independent verifier certifies the company only achieved a 22% emissions cut, missing the 30% target.
3. From year 5 onward, the coupon steps up to 4.75% for the remaining maturity — investors are compensated for the miss, and the company faces a real, quantifiable cost for falling short, unlike a green bond where a spending shortfall carries no direct coupon consequence.

What this means in practice

Investors evaluating a green bond need to check the framework and post-issuance reporting quality, since the financial terms of the bond itself don't enforce anything — the discipline is external. Investors evaluating an SLB should focus on whether the target is genuinely ambitious and the step-up is large enough to matter, since a token 5 basis point step-up on an easily achievable target provides little real incentive; several early SLBs were criticized for exactly this kind of weak, non-binding target design.