Fabricating Bonds: The Role of Emerging Sustainability-Linked Bonds (SLBs) in Revolutionizing the Textiles Industry
Sustainable Finance in Fashion
Sustainable finance is the investment decision considering environmental, social, and governance factors of an economic activity or a project where investors are willing to invest their money. It comes from equity and debt instruments such as bonds and loans. Sustainability-linked bonds have become a trend among various fashion giants in recent years where luxury companies such as Chanel, H&M, and Burberry have been using the proceeds from such bonds to reach their environmental targets such as reducing scope 1, scope 2, and scope 3 emissions, transition to renewable energy, waste reduction, and increasing the adoption of sustainable material in textiles. The performance of companies issuing such bonds is measured against the pre-defined key performance indicators (KPIs) verified by the Science Based Targets Initiative and second-party performance reviews. The lower the sustainability performance of the company, the higher will be the interest rate for the investors, which is considered a financial penalty to the company.
The demand for this type of conservation finance has become so popular that investors have oversubscribed the initial tranche of bonds for most companies like H&M, Adidas, etc. The main reason for an investor to put money into SLBs is that if the borrower fails to complete its sustainability target, it has to pay higher interest to the investors. Further, these bonds incentivise organizations to improve their sustainability performance at a cheaper rate. Heightened adoption of the ESG lens by investors has also led to the emergence of sustainable funds such as The Good Fashion Fund, an initiative to finance the implementation of highly impactful & disruptive production technologies in Asia in the textiles and apparel industry.
Borrowers receive proceeds from sustainability-linked, green, and blue loans to mitigate organizational climate challenges. For instance, Indorama Ventures received a $300Mn blue loan from IFC and ADB for a Waste Heat Recovery (WHR) project at its PET and fiber manufacturing facility in Indonesia where energy efficiency (EE) measures are expected to reduce the facility’s carbon footprint by 25%.
Table 2: List of Fashion and Apparel companies adopting Sustainable Bond
The oversubscription of bonds for the mentioned fashion companies highlights a strong investor appetite for sustainable investments within the fashion industry. For instance, H&M's bonds issued in February 2021 and October 2023 were oversubscribed by 7.6 and 3.5 times respectively. Similarly, Adidas and Burberry experienced oversubscriptions of more than 5 times and 7.9 times respectively. These figures resulted in fashion companies raising amounts significantly higher than their initial expectations.
Based on the provided data, the average issuance size for a fashion company's bonds is approximately €237.5 million. These bonds typically have an average maturity period of 7 years. This data underscores the robust demand for sustainable bonds in the fashion sector, indicating a growing trend towards environmentally conscious investing within the industry.
Strategic Advantages of Sustainable Finance for Businesses The demand for sustainable finance has increased among the big giants and large enterprises taking loans to make their operations sustainable. For instance, Sri Kannapiran Mills, a Coimbatore-based firm, has taken a loan of $ 2.5 million to replace and expand the key sustainable equipment in two of their spinning factories and a Denim fabric weaving & processing factory. The firm secured funds from The Good Fashion Fund. Availability of such funds direct investments only in sustainable initiatives and secure the investors’ money with the lens of ESG in their investment portfolio. The benefits of adopting sustainable finance are as follows:
- Cost-effective capital acquisition: Sustainable bonds and loans are intricately connected to reduced interest rates that are contingent upon the organization's sustainability or environmental, social, and governance (ESG) performance, a validation often conducted by second-party assessments. Research indicates that companies prioritizing ESG factors or financial sustainability tend to outperform their counterparts, translating into lower credit risk. These financial instruments are viewed as positive incentives, offering lower borrowing rates or pricing benefits to organizations demonstrating strong sustainability practices.
- Increasing investors’ appeal: As consumers increasingly prioritize environmental, social, and governance (ESG) criteria in their investment portfolios, there has been a notable trend of oversubscription in the initial tranches of sustainable bonds issued by companies like H&M and Adidas. This heightened demand has empowered these companies to either raise the prices of their bonds or increase the total amount of capital raised.
- Driving organizational impact: Through targeted and allocated capital aimed at enhancing sustainability practices within their supply chains, major fashion houses have witnessed significant improvements in greenhouse gas (GHG) emissions within their manufacturing units due to increased use of renewable sources of energy, and recycled materials. For instance, in 2023, Prada increased its procurement of electricity from certified renewable sources to 86%, a notable rise from 66% in 2022.
- Augmented brand equity: Brand equity is the value of a brand, based on customers’ thoughts and feelings, and it provides an added value to the product that contributes to the company’s long-term interests and capabilities. According to the Brand Finance Global 500 report, there is a significantly enhanced role for sustainability in driving choice in the luxury apparel sector. This shows that purpose-driven brands resonate with customers. Moreover, the guarantee of attributes of sustainability especially in luxury brands acts as the purchaser’s status, taste, identity, or ethics to others. Further, regular reporting and disclosures about the use of proceeds from green bonds build and enhance the investor's confidence.
- Driving growth through Innovation: The University of Cambridge Institute for Sustainability Leadership found that companies prioritizing sustainability are more likely to be innovative, with a higher likelihood of introducing new products and services. For instance, Indian brands like Sarjaa and Malai, are incorporating fruit leather in their products.
Value Proposition to Investors
- Balancing returns to investors: While sustainable bonds typically offer lower interest rates compared to conventional bonds, companies mitigate this through cash premiums paid to investors if they fail to meet the sustainable performance targets associated with the bonds. These premiums serve as penalties, ensuring companies uphold their climate commitments.
- Lower risks: Credit rating agencies are increasingly integrating environmental, social, and governance (ESG) factors into their credit ratings, offering a more holistic assessment of an issuer's risk profile. Additionally, the issuance of sustainable and green bonds includes mandatory second-party reviews that evaluate a company's progress toward meeting climate targets, with these reports made publicly available. This ongoing monitoring and transparent reporting serve to mitigate the risk of borrower default, providing investors with greater confidence in sustainable finance instruments.
- Diversifying the portfolio: Investing in sustainable and green bonds enables the diversification of risk across various projects and sectors focused on environmental sustainability. This approach leads to a more balanced and resilient portfolio, mitigating risks associated with any single project or sector and offering investors a broader exposure to sustainable initiatives.
Green and sustainable bonds share similarities with conventional bonds in terms of fixed income and duration. However, they offer additional advantages to retail investors by potentially reducing credit risk over time through the financing of climate-friendly projects. Moreover, they can assist in mitigating climate change-related risks in portfolios, particularly those arising from policy shifts like carbon taxation. Furthermore, investors in several countries such as India, the US, China, Kenya, Brazil, and Chile, among others, benefit from the tax exemptions on income derived from green bonds.
Chanel’s commitment to sustainability
Chanel, a luxury giant, raised €600 Mn by raising sustainability-linked bonds in 2020 in two lots of €300 Mn each for a period of 5.5 and 10.5 years respectively. The sustainability performance targets (SPTs) against which the performance of the company is to be measured are:
- Decrease scope 11 and 22 emissions by 50% by 2030 (compared with a 2018 base year) - equivalent to 66% per unit sold
- Decrease scope 33 GHG emissions by 10% by 2030 (compared with a 2018 base year) – equivalent to 40% per unit sold
- Shift to 100% renewable electricity in its operations by 2025
Company’s Sustainability performance
Taking the year 2018 as the baseline, Scope 1 and Scope 2 emissions of Chanel have decreased by 40% in 2022 but Scope 3 emissions have increased by 21% in the same.
Source of data: Chanel Performance Update reports 2020, 2021, 2022
Scope 1 and Scope 2 per unit emissions have reduced by 37.7% but per unit scope 3 emissions have increased by 2.8% in 2022. The above data shows that Chanel has to significantly reduce its Scope 3 emissions to prevent default on its SPTs. Defaulting on SPTs will require Chanel to pay 50 bps and 75 bps of the value of 5.5-year and 10.5-year bonds to the investors as a penalty which would amount to at least €3.75 Mn, given the value of the bond remains at par.
The impressive increase is seen in the use of renewable energy. 97% of the operations in 2022 of Chanel are running now on renewable sources of energy as compared to 41% in 2018, depicting a growth of 6.5%. With this growth rate, they will shift to renewable energy by 2025. This increase is mostly a result of power purchase agreements (PPAs) between Chanel and various renewable energy developers for the long term where developers supply Chanel units with renewable energy.
Returns to an investor
*Cash premium will only be paid to investors if Chanel defaults on its SPTs
According to the Luxembourg Stock Exchange, the yield to maturity for 2026 bond notes stands at 3.809% while it is 3.856% for 2031 bond notes. The face value has touched a 52-week low of 92.435 and 81.559 for 2026 and 2031 bond notes respectively.
Prada's Stylish Shift: Embracing Green Energy for Sustainable Fashion
- Number of stores assigned a LEED Gold or Platinum Certification;
- Amount of training hours for the employees;
- Use of Prada Re-Nylon (regenerated nylon) for the production of goods
Further, the company also raised new loans worth €90Mn (Feb 2021), and €100Mn (Jul 2021). These loans are five-year term loans whose interest rate can be reduced following the achievement of the following targets related to:
- the regeneration and reconversion of production waste;
- the increasing share of self-produced energy.
Company’s sustainability performance
- Prada has become a luxury retailer with the most certified LEED stores. LEED is the most widely used green building voluntary rating system. The number of stores in 2023 is 7.5 times what it was in 2018.
- The average number of training hours per employee has increased by 141% from 2018 to 2023.
- Further, the company targets to use renegrated nylon in the future production of its goods and it achieved full conversion to Re-Nylon in 2021.
- Prada is on track to produce self-generated energy by deploying photovoltaic systems in its manufacturing sites. The group has 18 photovoltaic systems in 2023 compared to 10 in 2019, recording an increase of 80%. Moreover, the group has increased its capacity to generate renewable energy by 64% in 2023 as compared to the baseline year 2019 and aims to double this capacity by 2026 (baseline 2019). On average, the group consumes 67% of its self-produced electricity to run its operations.
- Further, more than 85% of the electricity purchased came from renewable sources in 2023 for its operations.
- The group has committed to sourcing 80% of nylon and polyester from recycled or bio-based sources by the year 2026. Currently, the group has sourced 47% of the nylon and polyester from recycled or bio-based sources in 2023 compared to baseline 2019.
