‘Second-party opinions’: a greenwash safeguard or just for show?

In a bid to bring credibility to the trillion-dollar sustainable debt market, which has yet to fully recover since declining from its 2021 peak, ESG rating agencies and consulting firms are increasingly offering SPOs to issuers, to assess how “green” their bonds and loans are.

The websites of the largest SPO providers boast that they can provide “independent” and “transparent” opinions on the alignment of a labelled debt with international standards, while giving “additional assurance on the credibility of the issuer or borrower”.

But dodgy sustainability deals being marketed through SPOs in Asia, alongside “overly positive” reviews, have cast doubt over the mechanism’s ability to curb greenwash risks.

Eco-Business takes a look at the track record of this niche tool in assessing the sustainable credentials of borrowers, whose interests it actually serves and whether regulatory oversight is likely to be extended to SPOs in the near future.

What is an SPO?

An SPO is one of the four main types of external reviews for sustainable debt transactions or frameworks. It discloses the alignment of bonds and loans to the market principles established by the International Capital Market Association (ICMA) and the Loan Market Association (LMA) respectively. 

Other kinds of external reviews for a labelled debt include verifying its sustainability performance post-issuance, certifiying it against a recognised standard and rating aspects of a transaction or framework.

But SPOs are by far the most preferred type of external review, at least for bond issuances. In 2023, 80 per cent of sustainability bonds in the Climate Bonds Initiative’s database have SPOs attached to them, up from 69 per cent the year before. 

“SPOs blow [other forms of external review] out of the water. It’s probably because they are not regulated and seem to be easy to get. They also seem to be more predictable in terms of what you’ll get if you attach it to an issuance,” said Daniel Cash, associate professor at Aston University who studies the credit rating industry.

A study published last year, which examined almost 1,300 corporate green bonds, found that in the absence of a credit rating, green bonds with SPOs enjoyed a measurable green premium, which refers to savings a borrower receives for environmentally-friendly projects.

SPOs for bonds versus loans

While SPOs for both sustainable bonds and loans are currently unregulated, only external reviews for the former debt instrument tend to be publicly disclosed. Based on LMA’s guidance, issuers of loans – which belong to a more private market – just need to communicate the SPO to financiers party to the transaction, and make it publicly available after “taking into account confidentiality and competitive considerations”.

Earlier this week, campaign group Rainforest Alliance Network (RAN) called into question the green credentials of millions of dollars worth of sustainability-linked loans (SLLs) that Japanese megabank Mitsubishi UFJ Financial Group (MUFG) had arranged for Singapore-based palm oil and paper company Royal Golden Eagle (RGE) since 2021, after RAN’s satellite analysis found deforestation within its concessions.

In response to these allegations, RGE said that the key performance indicators (KPIs) underpinning the loan – which include using 100 per cent no deforestation, peatland clearance or exploitation-compliant suppliers by 2025 – were approved by its creditors, based on an SPO conducted by sustainability consultancy Environmental Resource Management (ERM).

When contacted by Eco-Business, ERM declined to comment on its SPO due diligence process for RGE’s SLLs and whether it has plans to update its assessment on the back of RAN’s study, citing its confidentiality agreement with RGE.

The opacity of the loan markets has led ICMA to publish a new guidance in June, aimed at improving the transparency for SLLs – a hot new asset class among banks in Asia.

Who are the main players?

Breakdown of SPO providers by SPOs produced in 2023. Source: Environmental Finance

The “big four” SPO providers are Morningstar’s Sustainalytics, S&P Global Ratings, ISS-Corporate and Moody’s.

Since acquiring Sustainalytics in 2020 in a deal valuing the firm at €170 million (US$190 million), Morningstar has become the largest SPO provider for sustainable debt.

S&P and Moody’s, which are the world’s two largest credit rating agencies, have entered the SPO market the same way they have tackled the ESG ratings space: through mergers and acquisitions. 

Since 2022, Sustainable Fitch – the sister company of dominant credit rating agency Fitch Ratings – and the global index provider MSCI have also started providing SPOs.

“Credit rating agencies are some of the largest players in there. They tend to buy their way in. For example, in December 2022, S&P bought the Shades of Green division from CICERO, the Norway institute for climate research,” said Cash.

In 2019, Moody’s acquired a majority stake in Paris-based SPO provider Vigeo Eiris in a deal understood to be worth around €50 million (US$56 million). In 2022, it subsequently transferred the SPO business from its ESG ratings arm to its credit ratings division. Back then, the ratings agency said that the transition “will strongly position us to meet market needs for… rigorous, consistent and independent analysis of the sustainability credentials of labelled debt.”

While Moody’s restructuring aims to address potential conflicts of interest for ESG raters who are also involved in producing SPOs, Cash said that if these “Chinese walls” erected between departments are anything like the ones in the credit ratings world between the analytical and commercial divisions, they “are easily breached”.

“There’s nothing that tells me that wouldn’t be the same with SPOs, especially if they’re not regulated. Because if they’re not regulated, what’s the penalty?”

Biggest drivers of SPO demand

ISS-Corporate’s executive director and sustainable finance business manager Federico Pezzolato as well as associate director and head of sustainable finance research Marie-Bénédicte Beaudoin told Eco-Business that this year, SPO demand has been driven by the global surge in green use of proceeds transactions.

They have observed the same traction in the Asia Pacific region, with additional interest in both public and private sustainability-linked structures. Transition finance – meant to help more carbon-intensive sectors become greener over time – is also an emerging topic, especially for jurisdictions that have included transition activities in their local taxonomies, they added.

Since S&P updated its SPO approach to include the Shades of Green methodology in July 2023, it has produced at least 72 SPOs – 40 were green, 17 were sustainability-linked and the remaining 15 were related to other use of proceeds (i.e. social and sustainability debt).

Are SPOs curbing greenwash in debt markets?

In February, Indian conglomerate Adani’s green bond issuance – earmarked for its renewable business – was deemed “environmentally positive” by Sustainable Fitch, even after climate finance watchdogs like Anthropocene Fixed Income Institute (AFII), Ekō and the Toxic Bonds Initiative flagged that banks helping to arrange the bond risk financing the parent firm’s coal expansion.

Sustainable Fitch did not directly address Eco-Business’ queries on whether it had taken into account concerns about Adani Green’s interconnectedness with the larger group when conducting the SPO for the US$409 million bond. 

However, Nneka Chike-Obi, senior director and head of APAC ESG ratings and research for Sustainable Fitch, replied in a written statement that “while Sustainable Fitch provides information about the issuer and its business for context, the scope of the opinion is limited to the transaction or framework.”

“This is in alignment with the ICMA’s guidelines for external reviews,” she added.

This was not the first time that an Adani subsidiary has been acccused of using an SPO to greenwash dubious transactions. In 2021, the lead managers of Adani Electricity Mumbai’s sustainability-linked bond (SLB) – which included MUFG – came under fire from AFII for failing to properly disclose its links with coal power.

The bond had been marketed using an SPO by Vigeo Eiris which stated that Adani Electricity was not involved in the controversial activities of coal or fossil fuels. But after the bond was priced, the SPO provider updated its statement, blaming the initial omission on an “administrative error”, though it maintained that this did not alter its opinion as to the bond’s sustainability credentials.

Without referencing any specific issuances, Sustainable Fitch’s Chike-Obi said that since “an SPO is a point-in-time evaluation” and “not a monitored evalution”, an issuer missing KPIs for an SLB would not necessarily require the withdrawal of the SPO. 

ISS-Corporate’s Pezzolato and Beaudoin similarly said that an SPO “is valid as long as there is no material change to the financing framework or loan structure. It is a picture of the intention set in the financing framework at the start.”

Ultimately, SPOs help institutional investors to communicate to regulators and their own clients that they have done their due diligence on a particular deal, and that they are not in breach of their fiduciary duties, which is a criminal offence, said Cash.

“They have essentially outsourced their due diligence, because an internal due diligence process is not strong enough for signalling purposes [to regulators and clients],” he said. “If they were to say to a regulator, ‘I’ve done my due diligence,’ they’d have to go through the whole process of proving what they did through documents and data. A lot of the regulators aren’t technically strong enough to understand that data.”

The sliding scale that credit rating agencies pioneered and is reflected in S&P Global’s Shades of Green, for instance, is “the easiest way” to communicate technical information to anybody, said Cash. “When you see the shades of green, you can understand that dark green is better than red.”

S&P Global Ratings differentiates between green and transition activities using its Shades of Green scale, where the dark green activities corresponds to a long-term vision Paris Agreement-aligned future, while red activities are inconsistent with the climate transition. Image: S&P

Whose interests do SPOs actually serve?

“Without a doubt, issuers especially from SPO providers with ‘issuer pay’ models,” said a former credit and ESG ratings analyst, who declined to be named. 

“It’s challenging to find an SPO that criticises a key performance indicator outright,” she said, adding that SPO providers have varying objectives they want to achieve through their SPOs, with some simply assessing whether a deal is aligned with market principles and others looking to enhance transparency by engaging investors and issuers.

“It’s a lot of high-level disclosure and assessments against certain benchmarks. But whether a transaction or framework, assessed in terms use of proceeds, or a sustainable performance target (SPT) is truly meaningful to the issuer’s overall sustainability is the bigger question,” she said.

For example, Japan’s largest steelmaker Nippon Steel inaugural green bond framework, launched last February, was considered to be aligned with ICMA’s green bond principles by Tokyo-based SPO provider Rating and Investment Information Inc (R&I). However, the SPO did not factor in its continued commitment coal-based technologies for steelmaking, albeit the manufactured components would go into “eco-friendly car motors”.

Nonetheless, the former analyst says that she does still see a place for SPOs. “They do give transparency and alignment with principles. But I think what would be helpful is to actually point out when something is not ambitious, relevant and meaningful,” she said. Even in credit ratings, both the factors that improve and weaken a borrower’s creditworthiness are included, and the same approach should be taken in SPOs, she said.

Further market consolidation and regulations expected?

In July, MSCI announced a strategic partnership with Moody’s, which saw the credit rater bowing out of the ESG ratings business. On the back of the tie-up, the fate of Moody’s-owned Vigeo Eiris, a dominant SPO player in Europe, remains uncertain.

Cash is “hearing through the grapevine” that almost everyone in the team has been made redundant, but he is still waiting to see if the SPO provider will be subsumed into MSCI. Moody’s has yet to respond to Eco-Business queries on this matter as of press time.

In March 2023, ERM also acquired Latin America-based SPO provider NINT, which was among the top 10 SPO providers last year, based on Environmental Finance data.

While market consolidation is underway in the SPOs space, Cash expects it to follow the trajectory of the ESG ratings world, where there will never be a complete monopoly. The issuers-pay model means that issuers can go “ratings shopping”, where they swing between raters to get the best rating. “That’s what keeps the ratings inflated,” he said.

While the European Union and India have become the earliest two jurisdictions in the world to mandate regulations for the ESG ratings market, Cash is doubtful that regulators in the EU and elsewhere will commit to regulating SPOs.

“They are most likely thinking that because the market isn’t massive at the moment, there’s no systemic risk… If this was happening with normal corporate bonds, this would be a systemic risk. That’s why credit ratings are regulated. Whereas, this [sustainable debt] market is not the same size as corporate bonds. It’s almost like at this early stage, you can allow the bubble to grow.”