Green bonds and sustainability-linked loans

What are green bonds and sustainability-linked loans?

Green bonds and green loans are use-of-proceeds instruments: the borrower commits to spend an equal amount on eligible green projects and to report on the allocation and, usually, the impact. Social and sustainability bonds work the same way for social or mixed projects. Sustainability-linked bonds and loans are general-purpose debt whose interest rate depends on key performance indicators, measured against sustainability performance targets: miss the target and the coupon steps up, or, in many loans, hit it and the margin falls. Market principles, such as ICMA's Green Bond Principles and the Loan Market Association's green and sustainability-linked loan principles, set the expectations for each.

How do issuers account for green bonds?

As ordinary financial liabilities. The commitment to spend on eligible projects does not change the contractual cash flows, so a green bond is usually measured at amortised cost using the effective interest method, with directly attributable transaction costs, which can include the cost of a pre-issuance external review, included in the effective interest rate. Ongoing allocation and impact reporting and post-issuance reviews are expensed as incurred. Unspent proceeds are ordinary cash or investments unless legally restricted. See the effective interest method.

How does a borrower account for sustainability-linked features?

A financial liability is measured at amortised cost unless it is held for trading, designated at fair value, or contains an embedded derivative that must be separated. A derivative's value changes with an underlying, but the IFRS 9 definition excludes non-financial variables specific to a party to the contract. Targets based on the borrower's own emissions, water use or safety record are generally treated as such variables, so most sustainability-linked debt has no separable embedded derivative. Features linked to market variables, such as an ESG index, need closer analysis and may have to be separated. IFRS 9 does not define the term, so the analysis is a judgement to document. The borrower then estimates the expected cash flows, including any expected step-up, and when expectations change it recalculates the carrying amount at the original effective interest rate, recognising the difference in profit or loss.

A sustainability-linked bond's step-up in practice

A company issues a EUR 300 million five-year sustainability-linked bond at par with a 2.5% coupon. If it has not cut scope 1 and 2 emissions by 30% by the end of year 3, the coupon steps up by 0.25 percentage points for years 4 and 5. At issue it expects to meet the target, so the effective interest rate is 2.5%. At the end of year 2 it concludes it will miss it.

Discounting the revised cash flows at the original 2.5% gives EUR 301.41 million, against a carrying amount of EUR 300 million, so the company increases the liability and recognises a loss of EUR 1.41 million in finance costs in year 2. Interest in years 3 to 5 is then 2.5% of the higher carrying amount. If its emissions later fall faster than expected and it meets the target after all, it reverses the adjustment the same way. The company discloses the target, the step-up and the judgement that the feature is not a separable derivative.

What changed for lenders in 2026?

A lender can measure a loan at amortised cost only if its contractual cash flows are solely payments of principal and interest. The IASB's May 2024 amendments to IFRS 9, effective for annual periods beginning on or after 1 January 2026, clarify that a contingent feature, such as an ESG-linked margin, can pass this test where the cash flows are consistent with a basic lending arrangement both before and after the change and, if the trigger is not directly related to basic lending risks or costs, are not significantly different from those of an identical loan without the feature. Small margin ratchets typically pass. Amendments to IFRS 7 require, by class, a description of the contingent events, quantitative information on the possible changes in cash flows, and the carrying amounts affected. See IFRS 9 classification.

What is the EU Green Bond Standard?

The European Green Bond Regulation has applied since 21 December 2024. Issuers that choose the European Green Bond label must allocate the proceeds to activities aligned with the EU Taxonomy, subject to a flexibility pocket of up to 15%, publish a factsheet and allocation and impact reports, and obtain pre- and post-issuance reviews from external reviewers registered with ESMA. The label is voluntary, and other green bonds can continue to follow market principles. See EU Taxonomy reporting.

What should be disclosed?

Issuers disclose the terms and carrying amounts of labelled debt, the judgements on embedded derivatives and expected cash flows, and the effect of any change in expectations. The sustainability report should use the same targets and performance figures as the bond documents, because inconsistencies are a greenwashing and assurance risk. See greenwashing risk.

This guide is general information. It is not tax or legal advice for your situation.