Global credit ratings business DBRS Morningstar says airlines have raised only $5 billion in sustainability-linked finance since 2018 but expects this to pick up as the aviation sector needs to invest around $175 billion annually to achieve net zero by 2050. In addition to the possible increase in funding, benefits of raising sustainable financing include enhancing ESG credibility and the potential to lower the cost of funding, explains DBRS in a client report. It says sustainability-linked bonds (SLBs) and transition bonds are likely to emerge as the key instruments of choice for the sector. However, airlines’ key performance indicators (KPIs) under their SLBs are likely to get more aggressive over the coming years as the market matures. “Although we do not expect material long-term impact in terms of credit implications, a failure by airlines to meaningfully tap the sustainable financing market could have consequences for liquidity and ratings in the long term,” notes Rohit Kumar, Assistant Vice President, Diversified Industries at DBRS.
The report says that given few avenues are available to decarbonise aviation in the short term, the chances of any material financial burden being imposed by regulators on airlines are limited. However, it warns, over the medium to long term, airlines that fail to meaningfully tap the sustainable financing market and/or adequately focus on new technologies could suffer from liquidity challenges and possible negative rating actions.
To date, the airline sector has completed only 16 sustainable finance transactions, according to DBRS (see table below), representing only a fraction of the overall financing needs of airlines, which globally raised $250 billion and $340 billion in 2020 and 2021 respectively. This low activity is partly because green bonds, which traditionally have been the most common form of sustainable finance, do not often fit airlines’ business model as the use of net proceeds is restricted to environmentally friendly projects, while airlines mostly raise funds to finance aircraft purchases.
“SLBs fall in the sweet spot as they do not restrict the use of net proceeds but rather link the financing cost to ESG targets. Transition bonds, which were introduced even more recently than SLBs, are also a viable option for high carbon-emitting industries like airlines, as they support projects that reduce the carbon footprint, such as fleet modernisation,” says the report.
“Going forward, we think SLB and transition bond activity is likely to grow from current modest levels. As a capital intensive industry, airlines need to maintain access to capital at a time when investors are becoming increasingly focused towards sustainability.”
DBRS believes sustainable financing can help airlines’ credit profile in a number of ways:
- As investors put more emphasis on ESG, an increased focus on sustainable financing might help the sector maintain access to a wider pool of capital.
- Airlines linking their climate goals with financing agreements enjoy more credibility on their targets.
- Funding costs will likely decrease as yields may be lower on SLBs compared with non-sustainable instruments.
- Airlines that are proactive in cutting emissions as part of their corporate-wide operating KPIs in their SLBs could benefit if regulators take more aggressive actions to accelerate decarbonisation.
However, DBRS is concerned that the medium-term climate targets set by airlines, and the KPIs under SLB transactions, are not always ambitious enough to achieve the long-term objective of net zero. While targets under some SLBs are set to reduce emissions intensity – emissions per revenue passenger kilometre (RPK) – the expected growth in travel activity could more than offset the attempt to reduce net emissions.
“For example, a target of 30% reduction in emissions intensity by 2030 compared with a 2019 baseline would still result in around 8% higher net emissions in 2030, assuming a 4% CAGR in RPK activity,” says the report. “Therefore we think airlines’ KPIs are likely to get more aggressive in the coming years and regulators may step in to tighten the framework under SLBs to prevent any greenwashing.”
The credit ratings agency foresees significant decarbonisation challenges for the aviation sector, such as the high cost of production of sustainable aviation fuels and the heavy investment requirements, plus the technological hurdles of electric and hydrogen powered aircraft, which are at least 10 years away from wide-scale adoption.
“Without sufficient global support from governments to offset the high costs, it might be challenging for the sector to build viable alternatives,” it concludes.
Sustainable finance transactions in the airline industry:
|Bond Type/ Framework||Date||Amount Raised ($m)||KPIs (SLBs)/Use of Proceeds (non-SLBs)|
|All Nippon Airways||Green bond||October 2018||88||Constructing a fully solar powered and environmentally-friendly training facility|
|Avation/BRA||Green loan||December 2019||n/a||Financed three low-carbon emission 72-600s planes built by ATR. These were bought by Singapore-based Avation and leased to BRA|
|Etihad Airways||Sustainable Development Financing||December 2019||111||Supporting expansion of the Etihad Eco- Residence, a sustainable apartment complex for the airline’s cabin crew|
|JetBlue||Sustainability-linked loan||February 2020||550||Pricing linked to JetBlue ESG Score provided by third-party ESG research provider|
|Etihad Airways||Sustainability-linked Sukuk||October 2020||600||Net zero by 2050; 50% reduction in net emissions by 2035; 20% reduction in emission intensity by 2025 compared with 2017 baseline|
|Aerofloat||Sustainability-linked loan||May 2021||320||Financing cost linked the company’s ESG performance assessed by MSCI ESG rating agency|
|All Nippon Airways||Sustainability-linked bond||May 2021||92||Completing at least two out of four targets by March 2023 which include (1) listing on DJSI World and DJSI Asia Pacific, (2) listing on FTSE¬4Good Index, (3) listing on the MSCI Japan ESG Select Leaders Index, and (4) rating A- or above on the CDP (Carbon Disclosure Project).|
|Korean Airways||Green bond||June 2021||175||Purchasing next-generation, eco-friendly Boeing 787 aircraft, which are 25% more efficient in carbon emissions and fuel efficiency|
|British Airways||Sustainability-linked bond||July 2021||554||8% reduction in emission intensity by 2025 compared with 2019 baseline|
|Volaris||Sustainability-linked bond||October 2021||75||Reducing carbon emissions by 21%, 24% and 25% in 2022, 2023 and 2024 compared with 2015 baseline|
|Etihad Airways||Sustainability-linked loan||October 2021||1,200||Targets tied to reducing carbon emissions, increase corporate governance, and promote female participation|
|Air France- KLM||Sustainability-linked loan||January 2022||n/a||Proportion of new-generation aircraft in Air France's fleet and future usage of SAF|
|Japan Airlines||Transition bond||March 2022||85||Proceeds to be used to upgrade to fuel-efficient aircraft (Airbus A350, Boeing 787, etc.)|
|Cathay Pacific||Sustainability-linked JOLCO||July 2022||n/a||KPIs focused on proportion of new-generation aircraft in Cathay’s fleet and the gradual increase in the use of SAF in the carrier’s fuel consumption|
|Viva Aerobus||Sustainability-linked bond||November 2022||50||Reduce jet fuel carbon emissions intensity per revenue passenger-kilometre by 35.4% in 2029 compared with a 2015 baseline|
|Air France- KLM||Sustainability-linked bond||January 2023||1,075||Reduce scope 1 and 3 jet fuel GHG emissions by 10% per revenue-ton-kilometre by 2025 and 30% by 2030 versus 2019|
Note: Scope 1 covers emissions from sources that an organisation owns or controls directly; Scope 2 are emissions that a company causes indirectly through the energy it purchases and uses; Scope 3 encompasses emissions that are produced by other entities that the company is indirectly responsible for, up and down its value chain.
Sources: DBRS Morningstar, Ishka
Photo: Air France-KLM raised just over $1 billion through a SLB in January 2023