The importance of being earnest: how sovereign sustainability-linked bonds can evade sustainability commitments

Sovereign sustainability-linked bonds (SSLBs) were launched with a bold promise: unlike traditional green bonds, they would hold governments financially accountable for missing sustainability goals. By tying debt costs to climate targets, SSLBs seemed to offer a clever way to align fiscal incentives with planetary needs. However, as early experiments by Chile and Uruguay show, reality is more complicated, and more political.

From Green Labels to Linked Promises
For over a decade, sovereign green bonds (SGBs) have been the flagship tool of sustainable finance. They commit proceeds to green projects but have been criticised for fungibility (money gets lost in the general budget), vague commitments and weak enforcement. SSLBs promised to resolve these flaws by shifting the focus from where the money goes to what results are achieved. Miss a target, and you pay higher interest. Meet it, and you might even be rewarded. On paper, this performance-based model looks like an elegant solution. In practice, design matters. And here the devil is in the detail.

Chile and Uruguay: Pioneers with Loopholes
Chile broke new ground in 2022 by issuing the world’s first SSLB. Targets included capping greenhouse gas emissions and boosting renewable energy. Uruguay soon followed, tying coupons to emission intensity and forest protection. Both countries presented their bonds as ambitious steps toward climate credibility. But closer inspection reveals loopholes. Chile’s penalties only kick in after most of the bond’s lifetime has passed, and even then the step-ups are small. Uruguay’s targets are calibrated against older baselines that make achievements look easier. Crucially, neither bond treats missed sustainability targets as a legal default. Investors cannot demand repayment.

The result? Governments secure cheaper borrowing up front, the so-called ‘free lunch’ effect, while the financial consequences of failure are modest at best. As Oscar Wilde might have put it, the importance of being earnest seems more rhetorical than real.

Between Idealism and Realpolitik
Philosophers from Rousseau to Kant have wrestled with the problem of promises. What makes a commitment binding: the written word, the penalty for breaking it or the moral will to honour it? SSLBs show that in sovereign finance, penalties alone may not be enough. When reputational risks are low and enforcement is weak, ambition shrinks to the level of what is politically convenient.

Toward a More Credible Design
If SSLBs are to deliver genuine sustainability, three reforms stand out. First, link proceeds to taxonomy-aligned activities, so investors can demonstrate real environmental impact. Second, replace pure penalties with positive incentives. Interest reductions for ambitious targets may encourage governments to go further. Third, strengthen external scrutiny, ensuring ‘ambition’ is measured against Paris-aligned science, not just national policy.

Without such changes, SSLBs risk joining green bonds as another chapter in the story of well-intentioned but under-performing tools. The stakes are high: sustainable finance cannot afford to be symbolism without substance. What matters now is moving from promises on paper to outcomes in practice.

To further explore this topic, read the full paper.