Sustainability-linked bonds could yet help investors to nudge issuers along net zero pathways, despite market contraction.
Major companies including AirFrance-KLM and hotel chain Accor recently disclosed they missed greenhouse gas emission reduction targets pledged in their sustainability-linked bonds (SLBs), triggering penalty payments to investors.
Experts argue this paradoxically strengthens rather than weakens the long-term credibility of the SLB market, which saw a rapid rise and was worth US$96 billion at its peak in 2021.
Since then, SLB issuance has fallen, in part due to allegations of greenwashing and concerns the instrument is not able to generate the required change in corporate behaviour.
According to the World Bank, Q4 2025 issuance of SLBs was 60.9% lower than 12 months previously. Overall, labelled bond issuance fell 17% in 2025 to US$904 billion from US$1083 billion in 2024.
“We anticipate a continuing reduction of SLB market size over the short term due to market participants’ current distrust and interrogations,” said Michaël Soued, Senior Portfolio Manager at Ostrum Asset Management. However, he also believes the market is evolving and that, in future, SLBs are well-positioned to capture a portion of the US$3.5 trillion annual transition finance gap.
“The recent wave of target misses signals market maturation rather than failure, creating opportunities for impact investors seeking both financial returns and accountability mechanisms. The SLB market is experiencing a critical evolution from ‘greenwashing theatre’ to genuine transition finance,” he claimed.
Jo Richardson, Head of Research at the Anthropocene Fixed Income Institute (AFII), struck a similar tone.
“In order for the product to be as effective as possible, we need ambitious and material targets. If you want the product to work, missing targets should be plausible,” she said. Out of the 17 SLBs the AFII analysed in 2024, four missed their targets.
Richardson also noted that the recent revisions to the EU’s Sustainable Finance Disclosure Regulation (SFDR) are likely to provide further impetus to the SLB market, given proposed reforms now include a transition fund category that was previously absent.
Other regulatory efforts to define and incentivise net zero transition pathways for issuers include transition planning reporting requirements and transition-specific taxonomies.
Transparency for investors
With a lot of SLBs having matured in 2025, reporting in 2026 is set to give greater insights into the performance of the market.
“While there have been some high‑profile instances of missed targets, our monitoring suggests that the majority of SLBs with a 2025 observation date remain on track to meet their objectives,” said Grover Burthey, Executive Vice President, Head of ESG Portfolio Management at PIMCO.
Observation dates are pre-defined annual or multi-year deadlines at which SLB issuers are required to report on bonds’ sustainability performance targets.
Burthey added that multiple factors can affect an issuer’s ability to meet targets, including external variables such as weather patterns or macroeconomic conditions. “That broader context should be considered when assessing performance outcomes,” he said.
AirFrance-KLM blamed supply delays in fleet renewal and longer flights times due to geopolitical circumstances for its failure to reach emission reductions as stipulated in its SLBs. Accor failed to give a detailed explanation, according to an assessment by AFII.
Moreover, Burthey argues companies that properly explain the drivers behind their performance increase transparency for investors and equip them with the information needed to contextualise outcomes. This also supports constructive engagement around what additional measures may be required to achieve the original objectives, he said.
As a general rule, if an SLB issuer fails to meet its targets, it must pay investors penalties in the form of a coupon step-up on the bond. But does the prospect of these penalties sufficiently incentivise SLB issuers to speed up their decarbonisation journey?
While current penalties are proving insufficient for large-cap issuers with substantial cash flows, the real deterrent is the future cost of capital, according to Ostrum’s Soued. “Missed targets create an ‘ESG risk premium’ that makes subsequent issuances more expensive,” he said.
Burthey added that SLB issuers may face heightened scrutiny and potential reputational consequences if they miss stated expectations, creating a meaningful incentive for companies to maintain their focus on sustainability targets.
Meanwhile for investors, SLBs include financial compensation when ESG promises fail. Soued insisted the appetite for the products remains, particularly among institutional investors with long-term mandates or impact investors. But it is vital that penalty structures create genuine financial consequences, KPIs are sufficiently sophisticated to capture real sustainability progress and market infrastructure enables transparent performance tracking.
SLBs vs green bonds
While SLB issuance has fallen, green bonds have continued to grow, reaching US$572 billion issuance in 2024, representing over half of the ESG debt markets globally.
Unlike green bonds, proceeds of which must be directed specifically to projects that deliver positive environmental benefits, SLB funds can be used for general corporate purposes. According to Soued, this is a lifeline for companies that don’t have enough specific green projects but want, nonetheless, to transform their entire operations. Hard-to-abate sectors, such as aviation, steel, and cement also require SLBs issues for structural reasons, he said, adding that green bonds are project bound, while SLBs can hold entire corporate strategies accountable.
Burthey agreed that SLBs form part of a broader toolkit available to issuers seeking to embed sustainability – and the funding of the net zero transition in particular- in their financing strategies.
“Not all sectors will have sufficient eligible capex needs to come to the market with green bonds; this is where SLBs open the room for wider participation by issuers,” he said, positioning SLBs as complementary to green bonds, expanding the reach of sustainable finance across the economy.
SLBs can incorporate sustainability targets beyond environmental indicators, said Burthey, providing an additional opportunity for issuers to address social or governance factors.
