The Skin-in-the-game Bond: A Novel Sustainable Capital Instrument

In this presentation, we introduce a novel sustainable capital instrument: the skin-in-the game bond. This bond is an alternative for the state-of-the-art green, social and sustainability bonds available on the market. The design of the skin-in-the-game bond finds inspiration in the construction of contingent convertible bonds (CoCos), established in the aftermath of the 2008 financial crisis. While the CoCo bond is mainly created for the banking sector, the features of a skin-in-the-game bond can be tailored to the specific characteristics of a company in any sector. 

A skin-in-the-game bond is linked to the performance of a benchmark that relates to the broad concept of sustainability in at least one of its pillars, being the environment (E), society (S) or corporate governance (G). A trigger value for the benchmark is fixed, indicating a high-risk situation heavily impacting society, either financially or health wise. When the benchmark hits the preset trigger level, investors miss out on a coupon payment or even forgo the complete face value of the bond. The skin-in-the-game bond therefore offers a higher yield to the investor than a standard corporate bond, in order to compensate for the risk of losing out on (part of) their investment. Upon a trigger event, the issuer is obliged to direct the withheld part of the face value into a government-controlled fund. 

The skin-in-the-game bond is built on the principle that both parties, issuer and investor, should have skin-in-the-game and suffer if sustainability promises are not delivered. The embedded financial penalty incentivizes the preservation of a favorable benchmark value and fights moral hazard risk. Also, transparency is enhanced; in order to monitor the trigger, the issuer is forced to publish reliable information on its sustainability-related commitments. Moreover, the involvement of an external fund ensures that the issuer is not exempt from payment and society may be compensated for the damage caused. 

Besides a discussion of the general concept of a skin-in-the-game bond, we will elaborate on a tailored valuation model as well as on an illustrative example of such a skin-in-the-game bond.