Why bonds?

Bonds are a debt security, like an IOU, where a corporation, government or other entity (bond issuer) sells the bond to many investors (bondholders) which lend money to the entity for a set period of time (maturity period) in exchange for regular interest payments (coupon rate). After the maturity period, the principal (also known as face value or par value) is repaid to the bondholder.

When a company wants to raise money they have two choices: equity financing or debt financing. Equity financing means giving up a percentage of ownership in the company by selling shares. Debt financing means companies have to pay back the funds over an agreed time period, plus interest. Companies pursuing debt financing can choose one of two routes: a loan from a bank or other financial institution, or by issuing bonds.

The primary market is where companies issue bonds and seek investors for their debt. The primary market should be thought of as the point of maximum leverage for increasing cost of capital to companies or disrupting bond issuance entirely. Financial institutions must stop giving fresh capital to fossil fuel companies via new bond issuance – or, as we say, deny new debt.  

Bonds are also traded on the secondary market (like shares). Bonds traded on the secondary market do not impact the current interest rate or face value of the bond when it reaches maturity. Thus, asking investors to divest from their existing bondholdings has less of a direct impact on money flowing to the issuing company, although it can send helpful market signals and lead a fossil fuel company to pay out higher interest rates on future bonds. 

The main focus of campaigners is on the primary market, and our main demand for financial institutions is asking them to stop investing in new bonds – or to deny debt. The primary market should be thought of as the point of maximum leverage for disrupting fossil fuel bond issuance. Financial institutions must stop giving fresh capital to fossil fuel companies via new bond purchases.

Issuing companies engage banks or other firms to advise and assist during the process. Banks enhance the credibility of the offer and ensure a higher chance of successfully issuing a bond. An investment bank’s role involves managing all aspects of the issuance process, including structuring the bond, preparing the prospectus, managing the roadshow and investor meetings, pricing, allocation and the listing process. 

In a large bond deal a group of banks will not only advise a company, but can each take a chunk of the bond deal (the “book”) and assume the financial risk for selling this onto investors. Banks will pocket the profits from the transaction. Companies seek out known and experienced investment banks for this role, such as Citi, JP Morgan and Barclays.

The bond prospectus is prepared in the issuance process which is a legal document detailing the terms of the bond, the issuer’s financial situation, and the potential risks associated with the bond. It’s prepared with the help of the underwriters and is essential for investors to make informed decisions.

Credit rating by a known agency is also important. The three large global credit rating agencies (CRAs) are S&P, Moody’s and Fitch. In certain jurisdictions local rating agencies are also well established and dominate those markets. CRAs evaluate the issuer’s creditworthiness and assign a rating to the bonds. A higher rating signifies lower credit risk, implying the issuer has a strong capacity to meet its financial commitments.

The last part of the bond issuance process is marketing and selling the bonds. The issuing company and its banks gauge market appetite under the proposed bond terms. The banks use their networks to find buyers. This often involves roadshows which include presentations and one-on-one meetings with potential investors in which they are introduced to the company, its history, and its key personnel. If not enough investor interest is achieved, the issuer and the investment bank may revise and re-launch the bond.

It’s very difficult to get advance notice of new bond issuance. The most notice the public usually gets it a few days before the bond is issued. This means there’s limited time to build a campaign to disrupt new bonds as they come to market.

However, companies need to keep refinancing their debt and seek continuous access to debt markets. Bond maturity dates therefore provide a more reliable indicator around when bonds will be issued to refinance the debt. Companies will seek to refinance their bonds up to a year in advance of their bond maturity dates. This is a key influencing moment.

The 100 days prior to a bond maturity (refinancing) is a key moment for influence. During this time, debt denial by investors who are not current holders of the company’s bonds would send strong market signals, but debt denial by existing bondholders is the best lever because the company is expecting these investors to refinance the bonds. 

If 10% of existing bondholders refuse to buy new bonds of a company, the company is placed under immense pressure to make up the financing shortfall and this is likely to increase cost of capital or even stop the bond issuance. Carbon-intensive sectors will face over $600 billion in bonds maturing each year through 2030 which they will likely need to refinance, providing an excellent opportunity to disrupt capital. 

Long-dated bonds are bonds that companies issue with a maturity date far into the future, often 20 years or more. These bonds promise to pay investors regular interest over a long period. However, as governments implement efforts to decarbonise, there is a high chance that many fossil fuel assets — like oil wells, coal mines, and power plants — will become obsolete or worthless. If global net-zero targets are achieved, studies find that half of the world’s fossil fuel assets could become stranded by 2036.

This means that investors buying fossil fuel bonds that mature well beyond key global climate commitment deadlines, are exposing themselves to significant financial risk. It also means that investors buying these bonds believe one of two things:

1. Fossil fuel companies will transition effectively away from fossil fuels… OR
2. Coal, oil and gas assets will not become worthless, but continue to be profitable well past agreed phase-out dates.

Major oil companies are issuing bonds with much longer maturities than before. This indicates that fossil fuel companies are making unrealistic predictions about future oil and gas demand. For example, Equinor expects a high price for Brent crude in 2050, much higher than the International Energy Agency’s forecast. These unrealistic expectations are leading companies to issue more long-dated and hybrid bonds to fund ongoing production, despite the likely decline in demand. The bond market is also not currently reflecting these risks in the pricing of long-dated oil bonds. The bond spread curves for companies like Shell and ConocoPhillips do not show significant changes, indicating that investors might not be fully aware of the potential pitfalls.

The majority of these bonds are ordinary bonds (sometimes called vanilla bonds). Meaning most of bonds are not explicitly supporting a companies transition, but are fresh cash for continuing business as usual.

But some of the bonds issued by fossil fuel companies and other corporations and governments are labelled bonds that can support transitioning finance from carbon intensive sectors. There are four main types of sustainably labelled bonds – green, social, sustainability and sustainability linked. This sustainably labelled debt represented 13% of the global corporate bond market in 2023 totalling over 0.98 trillion USD and is projected to increase to 14% in 2024.

Green bonds are the most common type of labelled bond, making up 59% of the sustainable bond market in 2023. Green bonds are use-of-proceeds bonds meaning the issuer must promise to investors that all funds are going to projects with specified criteria. For green bonds, the funds are earmarked or ring fenced exclusively to finance projects with environmental benefits including renewable energy, green buildings and sustainable agriculture.

Social and sustainability bonds are also use of proceeds. Social bonds are for projects that address specific social issues such as health care, food security or access to education. Sustainability bonds are a blend of social and green bonds – projects with both environmental and social benefits.

Sustainability linked bonds (SLBs) are the other common type of sustainability bond. Non financial corporates dominate the SLB market, issuing 83% of SLBs in 2023. They are particularly popular in hard to abate sectors, such as utilities and industrials which can find it hard to ring-fence projects through green bonds. Unlike green bonds, SLBs focus on outcomes, allowing companies to decide how best to deploy the funds as long as they meet their sustainability objectives. They are not linked to how the proceeds are used but instead require the issuer to set specific key performance indicators (KPIs) that they must meet within a specified time frame before the bond matures. Some common KPIs include a reduction in CO2 emissions or an increase in renewable energy production. These KPIs are tied to the business more broadly, rather than specific projects. In order to incentivise issuers to meet these targets, the SLBs are typically tied to a financial penalty. Most commonly SLBs have a ‘step up penalty’ meaning that if the issuer fails to meet the targets, it has to pay out a higher interest rate to investors.

Transition bonds make up the smallest portion of sustainable debt. They can be either sustainability-linked or use-of-proceeds bonds issued specifically to support climate transition goals, geared toward issuers in hard-to-abate sectors. Projects those bonds support may not always be “green”, but still aim at supporting the climate transition

The signalling effect of the labelled bond market is also quite a powerful driver of issuance. Issuing a sustainable labelled bond both signals that the bond is funding ‘good’ projects – helping to bring sellers and buyers of bonds together – as well as showing that the issuing company has a transition story to tell.

But alongside this rapid growth comes quite a lot of greenwashing, as companies try and take advantage of strong investor demand. Things such as weak targets for SLBs or green bonds freeing up capital for fossil fuel expansion have been widely critiqued.

A toxic bond is any bond issued by a fossil fuel company with expansion plans for coal, oil or gas.

Bonds are a key source of finance for fossil fuels and are increasingly being used to raise money for coal, oil and gas expansion. Out of the largest 100 emitters – responsible for almost 75% of global greenhouse gas emissions – only 30 are listed on equity (stock) markets, but all are dependent on bond markets for their financing. The Toxic Bonds Network has to-date identified the top thirty corporations – the Dirty 30 – issuing bonds as a back-door way to finance major fossil fuel expansion.  

In 2000, the fossil fuel industry was still raising almost three-quarters of its required capital through direct loans from (primarily) banks. 14% came from bonds, and a similar percentage from shares. Twenty years later, bonds have become the most important source of financing: the fossil fuel industry raises over half of its capital with bonds. Direct loans cover 45%, while shares barely factor in at 4%. In fact, all of the 100 biggest emitting companies are dependent on the bond market for their financing – while only 30 are listed on stock markets.

Companies can often borrow much larger sums with lower interest rates via bonds compared to bank loans. Bonds also typically have fewer restrictions compared to bank loans and don’t involve handing over any control of the company to investors, as with shareholdings. Thus, by issuing bonds, fossil fuel companies can enjoy less public scrutiny, less transparency, and ready access to trillions of dollars of debt.

As banks start to limit their lending to carbon-intensive industries, coal, oil and gas companies are turning more to the bond market as a safe haven. As a result, the fossil fuel industry has used bonds as a back door for raising large sums of money for expansion.

To limit global warming to 1.5 degrees there is no room for new fossil fuel projects. Every time investors buy fossil fuel debt  they are helping drill a new oil well or open a new coal mine. The course of action therefore is clear: financial institutions must deny new debt to expansionary fossil fuel companies. Click here to view detailed demands.

Investors – pension funds, insurers and asset managers – must stop all new bond purchases in companies expanding fossil fuels and divest existing bond holdings, including in passive funds, from fossil fuel companies that do not have adequate phase out plans in line with 1.5C. 

Banks must stop underwriting bonds for companies expanding fossil fuels.