Sustainability-linked bonds and loans

A sustainability-linked bond (SLB) turns the green bond idea around. A green bond controls where the money goes. An SLB does not: the issuer can use the money for any general purpose. Instead, the bond's financial terms are tied to whether the issuer meets sustainability targets it has set for the whole company.

The usual mechanism is a coupon step-up. If the issuer misses its target by a set date, it pays a higher interest rate for the rest of the bond's life. The investor is rewarded if the company fails; the company is rewarded (by avoiding the penalty) if it succeeds.

SLBs suit companies that cannot easily ring-fence green projects but can commit to company-wide goals, such as cutting emissions intensity or raising the share of renewable power. They are especially relevant for heavy industry, where much of the transition happens inside existing plants.

The same structure exists for bank loans, called sustainability-linked loans (SLLs). The interest margin goes down if targets are met, or up if they are missed.

The five building blocks (ICMA Sustainability-Linked Bond Principles)

1. Selection of KPIs: the key performance indicators must be relevant and material to the issuer's business, measurable and verifiable. A steel company's KPI should be emissions intensity, not paper use in offices.
2. Calibration of SPTs: the sustainability performance targets must be ambitious, meaning better than business as usual and ideally consistent with science-based paths.
3. Bond characteristics: what changes if the target is missed (usually a coupon step-up) and when it is tested (the observation date).
4. Reporting: at least yearly updates on performance against each KPI.
5. Verification: independent checking of performance against each target.

Illustrative example (hypothetical numbers)

A company issues a 7-year SLB with a 7.50% coupon. Its KPI is Scope 1 emissions intensity, and its target is a 20% cut from a stated baseline by the end of year 4. If the target is missed, the coupon steps up by 25 basis points to 7.75% for years 5 to 7.

On ₹1,000 crore of bonds, the penalty would be about ₹2.5 crore a year for three years. Compare that with what it would cost the company to actually meet the target. If meeting the target costs far more than the penalty, the step-up may not change behaviour.

SEBI's ESG debt securities framework (June 2025)

On 5 June 2025, SEBI issued a framework for social bonds, sustainability bonds and sustainability-linked bonds, which together are called ESG debt securities. Green bonds stay under their own separate rules. Key points:

• SEBI defines an SLB as a debt security whose financial or structural features are linked to predefined sustainability objectives, measured through KPIs and assessed against SPTs.
• Only bonds aligned with recognised standards or definitions, such as ICMA's or the Climate Bonds Standard, can use these labels.
• The issuer must appoint an independent third-party reviewer or certifier to confirm that alignment.
• Issuers must make both initial disclosures (at issue) and continuous disclosures (over the life of the bond).

Sustainability-linked loans

SLLs follow the Sustainability-Linked Loan Principles published by the main loan market associations. The structure mirrors SLBs: KPIs, targets, a margin ratchet up or down, yearly reporting and verification.