Striking the right note: Key performance indicators for sovereign sustainability-linked bonds

Governments in many countries are looking for innovative financial instruments to address the triple crisis of unprecedented debt levels, climate change and nature loss. Sovereign bonds - representing almost 40% of the $100 trillion global bond market -- are the largest asset class in many institutional investors' portfolios. They are one of the key instruments for channeling capital to emerging markets and developing economies (EMDEs). Yet many developing countries are unable to deploy the capital needed to take action to avoid negative impacts of climate shocks and nature loss, particularly following the pandemic crisis.

One instrument to link sustainable sovereign financing with national climate and environmental commitments could be sustainability-linked bonds (SLBs), which are growing fast in the corporate debt market and are now being considered for sovereign issuers. These financial instruments aim to incentivize the borrower to achieve ambitious, predetermined sustainability performance objectives, measured using key performance indicators (KPIs). Unlike green and other sustainability-labeled bonds, SLBs are not ring-fenced for particular projects or spending; rather, the payout to investors in the bond depends on whether the issuer meets agreed-upon performance indicators.

A new World Bank report - Striking the Right Note : Key Performance Indicators for Sovereign Sustainability-Linked Bonds - presents a framework to bridge the gap between what sovereign investors would view as appropriately ambitious actions and what issuing countries see as achievable targets. Building on the "Sustainability-Linked Bond Principles" set out by the International Capital Market Association (ICMA), the report provides initial guidance on what a framework for assessing the suitability of KPIs might look like. The metrics include whether a potential indicator is sufficiently robust, properly interpreted, aligned with the country context and credibly ambitious. The report outlines a top-down approach, designed to make the KPI setting and monitoring process as simple as possible, while considering countries' priorities and context.

Table 1: Framework for Assessing Robustness of Sovereign SLB indicators + targets

Indicator Assessment Criteria	Target Setting Assessment Criteria
Available	Alignment with internationally agreed goals
Attributable	Eligibility Criteria
Frequent / Recent	Benchmarking with comparable countries
Regular	Baseline Targets
Comparable across countries	Planetary Boundaries

The report screens existing datasets to identify potential KPIs that could be used by sovereign SLBs to determine sustainability performance objectives (with a specific focus on climate- and nature-related objectives). Leveraging existing datasets established by respected third parties could reduce the administrative burden for small government debt management teams, encourage standardization and introduce confidence in these new instruments. Many of the indicators included in this report's long list are common to multiple datasets and are already being used as KPIs in various contexts. The identified KPI list should evolve over time to reflect the most important development, climate and environmental priorities. For example, the list could be updated based on ongoing policy developments and international negotiations at the United Nations Framework Convention on Climate Change [UNFCCC] and Convention on Biological Diversity [CBD] Conferences of the Parties meetings.

The report proposes a set of criteria for assessing data robustness, including:

• Are the data available at a reasonable cost or publicly available for the foreseeable future?
• Can the indicator be plausibly associated with sovereign interventions?
• Are the data current and produced with enough frequency?
• Are the data provided regularly and over a considerably long period of time?
• Are the data within datasets consistent across countries?

One of the key challenges of using existing datasets as KPIs for sovereign SLBs is the lack of timely data. It will be important to establish methods to define acceptable reporting periods and to determine how and when to credit sustainable performance. Emerging technologies could potentially address this challenge by providing real-time data in the future, although further testing is needed to evaluate whether such solutions are appropriate in the EMDE context.

Attribution of outcome-based indicators is a particular challenge for sovereign SLBs - as these may depend on factors outside the government's control - and ensuring alignment with country context also needs attention. Additional screening may be needed for certain KPIs to assess their true contribution to sustainability performance objectives. A combination of short-term and policy indicators and long-term outcome indicators could be used to ensure that the results are aligned with long-term development goals and reflect real sovereign interventions rather than factors outside the government's control.

There are also various ways of assessing the ambition of targets. Potential options include:

• Assessing alignment with internationally agreed goals (e.g.1.5-2°C temperature goals under the Paris Agreement).
• Developing eligibility criteria (for example, positive or negative lists).
• Benchmarking with comparable countries.
• Issuing baseline targets (for example, targets relative to a base year or a business-as-usual scenario).
• Assessing planetary boundaries (for example, the level of resources that meet people's needs without exceeding critical planetary boundaries).

Each of these options have their own pros and cons that should be carefully considered.

Putting an economic value on many KPIs (such as biodiversity measures, water or air quality) is still an emerging concept. Making the link between sustainable outcomes, economic impact - and ultimately market pricing - through KPIs will therefore have to be an art in the initial stages, as is the case with the start of most new financial instruments. Further analysis will be needed to better understand how to price and trade sovereign SLBs efficiently, as this will be critical to ensure the scalability of the market in the long run. EMDEs with high cost of capital (and large natural capital resources to protect) are likely to be the most interested in sovereign SLBs. The issuance of these instruments must contribute to an improvement in debt sustainability and not lead to further increases in these countries' debt burdens.

The report recognizes that country pilots and consultations are needed to further understand how KPIs for sovereign SLBs could be developed in practice to address the triple crisis. The World Bank team looks forward to further collaboration with partners to help governments and investors sing in tune by using the right indicators.

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