HomeBlogFinanceSembcorp coal deal raises concerns about distortions in green bonds

Sembcorp coal deal raises concerns about distortions in green bonds

Shareholders in Sembcorp Industries have approved the $1.5bn sale of its Indian coal power plants in a deal that allows the Singapore-based company to avoid higher interest payments on its green debt even as it retains liabilities in the polluting assets.

Sembcorp, an energy provider, has agreed to offload the assets to a private Omani consortium to cut its greenhouse gas emissions and avoid triggering higher coupons on its sustainability-linked debt.

As part of the deal, it will also finance the assets for the next 15 years because it said restrictions on non-green investing would mean any buyer could find it difficult to secure financing for coal.

The unusual arrangement is being closely watched for signs that the nascent market for sustainable bonds could incentivise distortions in the way companies manage high-emitting assets. Sembcorp’s move also raises the question of whether sustainability performance targets should include both operational and financed emissions, and comes as world leaders gather for the COP27 climate summit in Egypt.

Sembcorp, in which Singapore state investment company Temasek has a 49.5 per cent stake, said the sale was a key part of its strategy to shift to green energy.

Its emissions intensity will subsequently fall from 0.51 tonnes of carbon dioxide equivalent per megawatt hour to 0.32 tonnes, comfortably within its target of 0.4 tonnes by 2025. However, the sale will also mean Sembcorp avoids paying additional interest on about S$975mn ($695mn) in 2021 sustainability-linked debt.

Sustainability-linked bonds are tied to targets such as carbon emission reductions. The cost of failure for the issuer is higher borrowing costs — creating an incentive for it to reduce emissions on the balance sheet. The International Finance Corporation (IFC), the World Bank Group’s private-sector investment arm, was an anchor investor in Sembcorp’s S$675mn sustainability-linked bond. BlackRock did not reply to a request for comment.

The Anthropocene Fixed Income Institute (AFII), a climate-focused non-profit, called the deal “carbon footprint arbitrage” and argued the Indian coal footprint should be retained by Sembcorp even after the sale.

Ulf Erlandsson, the non-profit’s founder, said the deal was one of the first examples of a green bond issuer effectively changing the premise on which it has been issued, by shifting a high-carbon asset off balance sheet while continuing to finance it. “Nothing’s really happening except that they are attempting to cut their carbon footprint,” he said.

Bond investors could be incentivised to push issuers to account for carbon on its balance sheet rather than “hiding everything under the carpet”, he argued, because this increases the chance the coupon will rise if targets are not met.

Sembcorp’s most recent green bond, issued in April, yields 3.735 per cent. But under the terms of the deal, the coupon paid would rise by 0.25 percentage points in 2026 if Sembcorp fails to hit its 2025 environmental target. By selling its Indian coal business, Sembcorp said it would achieve that target “ahead of time”.

“The option of retaining SEIL [the India coal unit] was considered, however, this could lead to a step-up in interest costs for [Sembcorp’s] sustainability-linked financing instruments,” it wrote to shareholders including BlackRock Institutional Trust Company NA, Vanguard and Norges Bank last month.

The IFC said that its investment in the bond reflected the World Bank’s plan to align financial flows with the goals of the Paris Agreement. It said its proceeds from the bond issuance could only be used for the financing or refinancing of renewable energy or other sustainable projects.

Mak Yuen Teen, a professor of accounting at the National University of Singapore, said the deal underscored how “NGOs, banks and investors should scrutinise to ensure that companies are not just using financial engineering to reduce their greenhouse gas emissions”.

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