A flood of ethical investors is driving down borrowing costs for companies selling debt used for environmental or social projects. That’s great if you’re a solar-panel maker, as you can issue low-cost green bonds to help pay for your new factory. Ring-fenced green funds don’t work so well if your business only spends limited amounts on infrastructure and research, or if your sustainability plans encompass a variety of different projects. That’s why fashion house Chanel opted to sell sustainability-linked bonds -- a relatively new type of debt that offers the potential cost benefits of green bonds without the spending restrictions. Instead, the notes hinge on companies pledging to do good and agreeing to pay penalties if they fall short of expectations.
By tying debt costs to measurable and verifiable companywide goals, known as key performance indicators, or KPIs. Issuers set targets with timetables and then make extra payments to bondholders if they fail to achieve them. The penalty could be higher coupons during the life of the bond or an additional payment on maturity. Chanel, for instance, agreed to give bondholders an extra 75 basis points when a 2031 bond comes due, if it misses an emissions goal.