Structural Loopholes in Sustainability-Linked Bonds

Sustainability-Linked Bonds—an innovative debt product that incorporates incentivizedsustainability targets—are becoming increasingly popular to encourage issuers to improve their sustainabilityperformance. However, existing Sustainability-Linked Bond structures allow issuers to weaken the link betweensustainability and financial outcomes, rendering Sustainability-Linked Bonds less effective. This paperexamines two potential structural loopholes on this front: late target dates and call options. The results show thatSustainability-Linked Bonds with coupon step-up penalties, which constitute the majority and benefit most from suchfeatures, are more likely to have later target dates and call options embedded. Larger penalties are associated witha greater likelihood of late target dates but not call options, which instead tend to be favored primarily byspeculative grade issuers. The paper also provides evidence that issuers with high carbon dioxide emissions are morelikely to resort to such structural loopholes. These findings suggest that Sustainability-Linked Bonds, despiteincentivized targets, may be prone to greenwashing.