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Everybody wants one

Are sustainable bonds the new smartphones?

The COVID-19 pandemic has highlighted the importance and fragility of the natural balance. As governments, companies and investors aim for a just transition, sustainable bonds are being issued at pace in different formats. Is it a fad, and do markets really need so many varieties?

Remember when the first smartphones came out? Save for a few ‘early adopters’ always keen to embrace emerging technology, many people were sceptical. They had few apps, wi-fi connections were patchy and data costs prohibitive. It was difficult to know what phone to buy, operator to use and contract to sign up for, amid a plethora of options with obscure terms and conditions.

Despite these drawbacks, smartphones slowly made their way through groups of influencers who made them fashionable. Eventually, offerings became clearer alongside a rapidly developing ecosystem of apps, free wi-fi, inclusive data and cross-border agreements. Today, smartphones are ubiquitous, we each have our preferences, and most know how to hunt for the best deal.

The universe of sustainable bonds is developing in a similar way. After years where only green bonds were on offer, adopted by few investors and looked on with suspicion by many, recent years have seen an acceleration in demand and supply. In 2020, the pandemic stripped companies and investors of the last veils they could hide behind to justify inaction on both climate change and social inequality. As a result, sustainable bonds are booming.

2020 saw the first issuance of sustainability-linked and climate transition bonds

According to financial markets data provider Refinitiv, issuance of sustainable bonds totalled $544.3 billion in 2020, more than double the previous year and an all-time record. While green bond issuance of $222.6 billion was also a record, the fact that 59.1 per cent of all sustainable bonds launched last year were in other formats highlights that an entire ecosystem has emerged in recent years. This includes social bonds and sustainability bonds, with 2020 also seeing the first issuance of sustainability-linked and climate transition bonds.

It feels as though we are in the first phases of democratisation of the market. Just as we once struggled to understand smartphone offerings, investors are grappling with the best way to support what the European Union has called ‘the just transition’ to combat global warming and inequality.

There will be a steep learning curve before sustainable bonds become mainstream, however this raises numerous questions. Should green bonds only be for green industries? What are the pros and cons of a sustainability bond compared with a sustainability-linked bond? Are climate transition bonds necessary or redundant? And, crucially, how can investors mitigate risks of greenwashing to ensure their money makes a difference?

Credit markets positioning for net zero

The sustainable bond market is growing for several reasons. The first, and most powerful, driver is the recent crop of regulation and setting of net zero emissions targets by big companies and national and supranational entities, such as the European Union’s (EU) Sustainable Finance Action Plan, aiming to support the transition towards sustainability after COVID-19.1

“Things like the EU’s Sustainable Financial Disclosure Regulation will also act as a push factor for investors, leading them to review how aligned their portfolios are to transition-related activities,” explains Richard Butters, ESG analyst at Aviva Investors.

Credit rating agencies are paying increasing attention to issuers’ ESG profiles and climate transition strategies

Credit rating agencies are paying increasing attention to issuers’ ESG profiles and climate transition strategies. On January 26, 2021, S&P Global Ratings said it was considering several downgrades among oil majors because of the growing risks they face from the energy transition.2

“Everyone is using the green bond market as a way of showing how green they are. Much as I don’t think green bonds are the end point, it is a great step because it has brought the issue to the forefront of everyone’s minds,” says Tom Chinery, investment-grade credit portfolio manager at Aviva Investors.

“Investors, issuers, company CEOs and senior management teams all want to get on the green bond train. And it means they are having to release all this data – not two years out of date, but in a timely and forward-looking fashion – on what they are looking to achieve in ESG. That really helps us in our analysis of companies,” he adds.

Green shoots

Companies are keen to tap into the surge in demand for greener investments, from asset managers and their clients. “Firms are realising this is an opportunity to obtain financing to achieve any of their broader strategic goals, and we are seeing growth in all parts of the market,” explains Butters.

Almost ten times more social bonds and three times more sustainability bonds were issued in 2020

Illustrating Butters’ point, $164 billion of social bonds were issued in 2020 – almost ten times higher than 2019, according to Refinitiv – while the $127.6 billion of sustainability bonds was more than triple that seen in 2019.

In comparison, because the sustainability-linked bond principles were only published in June 2020, just four companies had issued under the framework as of September 2020: Enel, Suzano, Novartis and Chanel.3

Figure 1: ESG bond issuance 2013-2020 ($ billion)
ESG bond issuance 2013-2020

Source: Bloomberg, Morgan Stanley Research, as of January 8, 2021

Issuers also come from an increasingly diverse set of industries, after years of being concentrated in the financial, real estate, utility and renewable energy sectors. In 2020, they included automobile companies, consumer and luxury goods firms and mobile phone operators.4

Butters is optimistic for issuance in 2021 as well, with companies likely to view the COP26 climate conference as an opportunity to showcase their environmental credentials, coupled with the wave of countries setting net-zero targets.

More companies will come to market as they transition their business models

“Companies tend to follow the broader policy environment of their own country, so I think many more companies will come to market as they transition their business model,” he notes.

However, investors must take care to read the small print when deciding whether a sustainable bond meets their criteria. A good example of this is Tesco, which issued a sustainability-linked bond on January 20, 2021.5

The company chose a framework whereby it has committed to pay a penalty if it fails to meet what at first glance appears an ambitious target – reducing its emissions by 60 per cent by 2025 against its 2015 baseline and going fully electric by 2030. However, this only includes Scope 1 and 2 emissions, whereas upstream Scope 3 emissions (i.e. those of its suppliers) account for almost a third of Tesco’s overall carbon footprint. The company has set a reduction target for Scope 3 emissions but did not include it in the deal.6 In fact, its commitment to switch to 100 per cent renewable power by 2030 merely follows UK government policy targets. In this light, it may not seem quite so ambitious.

This highlights two difficulties investors must contend with. Firstly, are some sustainable bonds better than others? Secondly, if a label cannot provide enough of a guarantee against greenwashing, how can investors ensure their allocations make a difference?

What bond?

The International Capital Market Association (ICMA) leads “a global market initiative bringing together all market participants and stakeholders from the private and official sectors”. It has created four sets of principles that collectively provide a framework for sustainable bonds: the Green Bond Principles (GBP), Social Bond Principles (SBP), Sustainability Bond Guidelines (SBG) and the Sustainability-Linked Bond Principles (SLBP), as well as the more recent ‘Climate Transition Finance Handbook 2020’.7

Figure 2: ICMA Guidance
ICMA Guidance

Source: The International Capital Market Association, as of February 4, 2021

ICMA-recognised green, social and sustainability bonds all have four components – use of proceeds, project evaluation and selection, management of proceeds, and reporting – to be verified through independent external reviews (second-party opinion, verification, certification and / or green bond scoring or rating).8

Sustainability-linked bonds (SLBs) aim to further develop the key role debt markets can play in funding and encouraging sustainability. Compared to the first three types, they are forward-looking.9

Figure 3: Green, social and sustainable bonds – key points

Bond type: Definition: Core components:
1. Use of proceeds 

2. Project evaluation and Selection

3. Management of proceeds

4. Reporting
Green Enable capital-raising and investment for new and existing projects with environmental benefits. Green projects that contribute to environmental objectives. The same process applies across types. The same principles apply on managing the proceeds. The same reporting requirements apply.
Social Proceeds used to finance new and existing projects with positive social outcomes. Social projects that aim to address or mitigate a specific social issue and/or achieve positive social outcomes. The same process applies across types. The same principles apply on managing the proceeds. The same reporting requirements apply.
Sustainability Proceeds exclusively used to finance or refinance a combination of both green and social projects. Green and/or social projects, as defined by the Green Bond Principles or Social Bond Principles. The same process applies across types. The same principles apply on managing the proceeds. The same reporting requirements apply.

Source: The International Capital Market Association, as of February 4, 2021

Figure 4: Sustainability-linked bonds – key points

Bond type: Definition: Core components:
1. Selection of KPIs

2. Calibration of SPTs

3. Bond characteristics

4. Reporting

5. Verification
Sustainability-linked The bond’s financial and/or structural characteristics can vary depending on whether the issuer achieves predefined sustainability/ESG objectives within a predefined timeline.

The proceeds of SLBs are intended to be used for general purposes.
The key performance indicators (KPIs) should be material to the issuer’s core sustainability and business strategy, address relevant ESG challenges of the industry sector and be under management’s control. The sustainability performance targets (SPTs) should be ambitious:

- Represent a material improvement and be beyond “business as usual”;

- Where possible be compared to a benchmark or external reference;

- Be consistent with the issuer’s overall sustainability / ESG strategy;

- Be determined on a predefined timeline, set before (or concurrently with) the issuance of the bond.
The SLB must include a financial and/or structural impact if the KPI doesn't reach its target by the predefined date.

The most common is a coupon variation, but other impacts can be considered. The impact should be "commensurate and meaningful".
At least annual, publicly accessible reporting on progress against the targets. As opposed to the pre-issuance external review, which is recommended, post-issuance verification is a necessary element of SLBs.

Source: The International Capital Market Association, as of February 4, 2021

The Climate Transition Finance Handbook provides additional guidance for issuers seeking to use green, social, sustainability bonds or SLBs in their climate transition strategy.10

Outside the ICMA ecosystem, the Climate Bonds Initiative (CBI) provides a “Climate Bonds Standard” certification of bonds and loans as being either green or aligned to the targets set out in the Paris Agreement. CBI does not reference the ICMA principles, though it does state that an issuer having received certification will “manage their bond proceeds properly”.11

Figure 5: CBI principles for climate transition bonds
CBI criteria for green and transition-certified bonds by activity

Source: The Climate Bonds Initiative, September 8, 2020

Finally, as stated by ICMA: “It is also recognised that there is a market of sustainability themed bonds, including those linked to the Sustainable Development Goals (“SDGs”), in some cases issued by organisations that are mainly or entirely involved in sustainable activities, but their bonds are not aligned to the four core components of the Principles”.12

Decisions, decisions

This wide variety of conventions adds to the confusion; investors will first need to be aware of the source of the “green” or “sustainable” labelling, then analyse the criteria and decide whether these are robust enough to meet their investment guidelines.

Green bonds have been around the longest but are beginning to look limited in scope

Within the ICMA taxonomy, green bonds have been around the longest but, as the transition accelerates, they are beginning to look limited in scope. Proceeds have not always been used to “dark green” ends, and this has been traditionally difficult to monitor. As an example, Repsol in 2017 controversially issued a green bond with the proceeds intended to improve the efficiency of oil refineries.13, 14

“Use of proceeds might go to green projects but might also go to other things. For example, some still view gas as a key part of the transition economy. It isn’t necessarily green, but somewhere in between the brown and green ends of the spectrum,” says Butters.

Because of such controversies, green bonds have tended to be the near-exclusive purview of already green or sustainable companies, limiting the options for more carbon-intensive firms to finance their climate transition efforts. For investors, this also creates concentration risk in the green bond universe, as few sectors are represented.

In addition, many ‘use of proceeds’ bonds fund prior investments. While this may indicate an issuer’s ability to use the proceeds responsibly, it raises questions as to how much of the funding should be retrospective. The recent issuance of a green bond by Tritax Big Box is a good example.15

“We do not look at green bonds per se and invest instead in the underlying company. On that basis, I really liked this issuance with clearly defined KPIs; the fact it was green just played a little into my relative value analysis. However, if we had been looking at it specifically as a green bond, I would have been looking for considerably less of the funding to be retrospective to increase the ‘impact’ that it has going forward,” says Chinery.

As the transition began to accelerate, markets needed new types of bonds that could better embrace the large transformation efforts of the wider corporate world. Enter SLBs and climate transition bonds.

“I am on the ICMA advisory council, giving input on how investors think about these things. I love sustainability-linked bonds, which are linked to a company’s whole business, because that is just how we look at it. A structure where companies release whole-business KPIs and then issue bonds attached to those is brilliant,” says Chinery.

Some of the worst companies that have really ambitious targets will make far more difference to the environment

In addition, because they have no exclusion on business type and allow financing beyond allocating proceeds to specific projects, it gives investors an opportunity to support meaningful efforts from a wider variety of companies.

“Some of the worst companies that have really ambitious targets that will make far more difference to the environment than a clean company that commits to shaving off .01 grams of carbon emissions a year. This is why I like the Enel approach: it is talking about massive global reductions in carbon emissions.16 That is meaningful for humanity,” explains Chinery.

There are live debates about the best way to implement SLBs’ impact framework and whether there is a need for specific climate transition bonds when so many other categories already exist (see How should SLBs work? and Do we need climate transition bonds?). But whether through a green bond, a conventional bond or the more recent SLBs, the key question for investors is to understand what is happening at a company level, and if the proceeds will help a business become more sustainable.

Influence and engagement

Sustainable bonds have two limitations. First, even the greenest bond does not necessarily mean its issuer is becoming more sustainable at the overall company level. Disclosure on the bond does not shed light on the underlying company.17

Buying green bonds can offer a way of participating in the transition

Of course, fundamental analysis on companies can be resource intensive; for investors with smaller teams, buying green bonds can offer a way of participating in the transition without having to do the research in-house. However, the impact can be limited, as green bond projects do not necessarily translate into comparatively low or falling carbon emissions at the firm level.18

In addition, investors need diversification to mitigate risk, and therefore cannot allocate solely to green sectors.

“The market is stuck between a rock and a hard place. Investors don’t want bad companies issuing green bonds, but they want diversification in terms of sectors and names. Historically, when investing in green bonds, it has been a struggle to achieve sector and name diversification, making it more difficult to run traditional risk mitigation and portfolio construction. That is one of the reasons why we like whole-company analysis,” says Chinery.

“There are about half a dozen different types of bonds in the pipeline, and you spend so much time trying to get your head around what they are and why they are relevant. We wouldn’t need them if companies were willing to put key performance metrics into their bond documents,” he adds.

As corporate disclosure improves, smaller investors with fewer resources can also benefit from the greater transparency

This is where engagement can make a difference, improving company disclosure on those key metrics, which in turn allows investors to keep engaging ever more effectively. And, as corporate disclosure improves, smaller investors with fewer resources can also benefit from the greater transparency, enabling groups of investors to be more aligned in their requirements and engagement efforts.

“A couple of years ago, we started engaging with housing associations – charities that don’t have equity ownership or ESG engagement – and a group of other investors. We are working through a third-party intermediary to assess what outcomes we should be looking for from these issuers,” Chinery says. “I am happy we are part of that group rather than half a dozen investors all sending slightly different ESG surveys. If we choose 30 metrics that we all agree on, it is much easier for the issuers to know where they stand.”

Addressing misconceptions

There is a common misconception that credit investors lack influence because they don’t have voting rights. That is not the case, particularly when they join forces, whether through industry bodies like ICMA, or internally, across credit and equity teams.

Bondholders need to be as engaged as shareholders are because we are as affected as them

“There is a legacy sentiment that stems from the fact you used to buy bonds and hold them to maturity, receiving coupons. Now bonds are actively traded instruments whose markets have grown hugely over the last two decades, so bondholders are affected by corporate decisions. We need to be as engaged as shareholders are because we are as affected as them,” says Chinery.

Butters agrees. “You can’t underplay the role credit markets have in company financing. As we have a greater sustainable finance policy environment, debt investors’ influence and the role they play will increase. When we engage at the issuer level, it can often set a precedent for cross-business activities. But the rise of sustainable debt also provides a new gateway for our voice to be heard, provided we engage with issuers to highlight any concerns of green or social-washing we might have when they use one of the sustainable bond frameworks,” he says.

No fad

One other aspect of sustainable bonds that investors and issuers will follow keenly over the coming years is how the cost of funding stacks up against conventional bonds. Perhaps the most obvious way to make comparisons is by looking at individual issuers with sustainable and non-sustainable bonds outstanding of the same tenor.

It is still too early to draw firm conclusions, but interesting nuggets of information emerge. The yield on Volkswagen’s 2028 green bond, for example, is marginally lower than its conventional bond of similar maturity (0.5 per cent versus 0.42 per cent as of February 9, 2020). This may reflect the relative sophistication and familiarity of European investors with sustainable bonds – the region accounted for over half of global issuance in 2020.

Meanwhile, in the US, the yields on Citigroup’s 2024 social bonds (0.61 per cent) and green bonds (0.86 per cent) are higher than its conventional bonds (0.53 per cent). Perhaps that is reflective of the US being behind Europe when it comes to sustainability, although who’s to say those spreads won’t narrow, and quickly, as the market evolves – as we have seen in Europe.

There is serious momentum behind the sustainable bond market globally

What we can say with more certainty is that there is serious momentum behind the sustainable bond market globally, and there seems little prospect of that trend reversing.

“Demand will still exceed supply in the short to medium term because, for green and social bonds, we are not at a stage where proceeds can cover the entire financing needs of a company due to limitations on project eligibility. For now, there will be a limited pool of proceeds available,” says Butters.

However, this could change faster than many expect. On February 9, Total announced a commitment to issue all of its new bonds through sustainability-linked debt – the first company to do so.19

“This is a bold move for an oil major, as it links all its future bond financing to sustainability targets. Failing to meet those will incur a greater cost of debt for Total. Pending the credibility of the those targets, this could provide a powerful incentive for the company to remain committed to change – particularly as its new issuance will primarily focus on longer-dated bonds, an important consideration in the context of the climate transition,” adds Butters.

The more investors focus on ESG in the bond market, the more the bad operators will see their borrowing costs rise

Total’s initiative could be a catalyst for others to follow. Although investors will have to be on their guard for instances of greenwashing, if enough issuers follow in Total’s footsteps it could be game changing.

“The more investors focus on ESG in the bond market, the more the bad operators will see their borrowing costs rise. There is no excuse for claiming it is too expensive to fund the transition. If a firm doesn’t engage on the net-zero pathway, the funding of its core operations will become too expensive, so it needs to be able to evidence good ESG practices,” says Chinery. “We are not at a point now where there is that level of dispersion, but it is the direction of travel.”

How should SLBs work?

The SLB Principles state: “The SLB must include a financial and/or structural impact if the KPI doesn't reach its target by the predefined date. The most common is a coupon variation, but other impacts can be considered. The impact should be “commensurate and meaningful”.”

In most cases, the coupon variation has been a commitment to increase the coupon if the issuer does not achieve sustainability performance targets by the agreed date.

“The easiest example to give is Enel: three years into the bond, if it hasn’t achieved a portion of its energy generation mix being renewable or a reduction in in its CO2 output, then the coupon will step up by 25 basis points (bps) until maturity. This seems to be the sort that is gaining most traction,” explains Chinery.

While this raises questions about the alignment of bondholder and issuer interests, in that bondholders stand to gain financially from the issuer’s failure to reach its targets, it can also be viewed in a more positive light.

“My view is that the company will outperform by being a good operator. If it fails to reach its targets, it means they are not such a good operator, so those additional 25bps are compensation,” says Chinery. “You can’t have it the other way where it would get a reduced coupon for hitting its targets, because a step-down coupon makes it very challenging for buy-and-maintain and Solvency-II-type books,” he adds.

Another option being discussed is an additional payment at the bond’s maturity rather than a coupon step-up in the middle of its lifetime. However, this would put additional stress on the bonds if the issuer needed to refinance the original principal at maturity.

The fourth option is getting the issuer to pay the additional money, via a lump sum or an annual coupon, to a charitable venture aligned with the issuer’s targets, but oversight would be complicated.

Investors might face a period of trial and error until the best way forward becomes clear.

Do we need climate transition bonds?

Two frameworks currently refer to “climate transition bonds”: The Climate Bonds Initiative and ICMA.20

ICMA’s framework proposes using existing sustainable bond principles and adds recommendations on issuer-level disclosures required to credibly position the issuance of the bonds to finance the transition, particularly of ‘hard-to-abate’ sectors.

Given the recent creation of SLBs, the advent of climate transition bonds has sparked a debate as to their necessity.

On the plus side, having these frameworks allows for greater consistency in the methodology and quality of transition-labelled bonds. The label also opens opportunities for carbon-intensive sectors to fund their transition, something that has not generally been accepted under the green bond principles. That is likely to make a much bigger difference for the planet than financing the green economy alone.

On the need for transition bonds now that sustainability-linked bonds exist, Marisa Drew of Credit Suisse believes SLBs can fall under the CBI’s transition framework in the same way they can fit into ICMA’s Climate Transition Finance framework, while issuers and investors that do not want a bond with its cost of capital linked to sustainability KPIs can use other instruments.21

Less positively, it could be argued that green, sustainability and SLBs are all designed to help issuers align with the Paris Agreement, and that adding a layer of labelling creates confusion. In the absence of a clear definition of what constitutes a transition, these frameworks could unwittingly create more latitude for greenwashing.

When compared with SLBs, transition bonds do not necessarily require forward-looking targets, but can be issued on a use of proceeds basis, which can serve to finance improvements that have already been made. This provides weaker support for the huge transition efforts still needed to meet the goals of the Paris Agreement.

“It comes down to what they are doing at the issuer level. If there ever was a transition bond, we would want it to be underpinned by the assurance that the company’s broader strategy is aligned to net zero and has set science-based targets,” says Butters.


For the purposes of this article, we refer to the universe encompassing green, social, sustainability, sustainability-linked and climate transition bonds as ‘sustainable bonds’.


  1. ‘Renewed sustainable finance strategy and implementation of the action plan on financing sustainable growth’, European Commission, 2021
  2. ‘Oil majors' credit ratings under threat from growing climate risks: S&P Global’, S&P Global Platts, January 26, 2021
  3. ‘ESG Matters - Global - ESG “Need-to-knows” for corporates: Green and labelled bonds, Part 2’, BofA Global Research, September 29, 2020
  4. ‘Tracking the environmental footprints of corporate green bond issuers’, Scope Group, February 1, 2021
  5. ‘Tesco's first sustainability-linked bond more than six times oversubscribed’, edie, January 21, 2021
  6. ‘Carbon footprint’, Tesco PLC, 2021
  7. ‘Green Bond Principles (GBP)’, International Capital Market Association, 2021
  8. ‘Sustainable finance’, International Capital Market Association, 2021
  9. ‘Sustainability-Linked Bond Principles (SLBP)’, International Capital Market Association, 2021
  10. ‘Climate transition finance handbook’, International Capital Market Association, 2021
  11. ‘Certification under the Climate Bonds Standard’, Climate Bonds Initiative, 2021
  12. ‘Sustainability Bond Guidelines (SBG)’, International Capital Market Association, 2021
  13. Sophie Robinson-Tillet, ‘Analysis: Investors divided by green bond from Spanish oil company Repsol’, Responsible Investor, May 11, 2017
  14. ‘Our approach: Research-based, independent and relevant’, CICERO Shades of Green, 2021
  15. Tritax Big Box REIT plc’, 2021
  16. ‘Sustainability-Linked Bonds’, Enel Group, 2021
  17. Neil Unmack, ‘Breakingviews - Green bonds could slide into irrelevance’, Reuters, September 17, 2020
  18. Torsten Ehlers, Benoit Mojon and Frank Packer, ‘Green bonds and carbon emissions: exploring the case for a rating system at the firm level’, BIS, September 14, 2020
  19. Francois de Beaupuy and Priscila Azevedo Rocha, ‘Total to sell only ESG-linked bonds in first for debt market’, Bloomberg Law, February 9, 2021
  20. ‘Climate transition finance handbook: Guidance for issuers’, International Capital Market Association, December 2020
  21. Marisa Drew and Jacob Michaelsen, ‘Head-to-head debate: Transition bonds’, Environmental Finance, November 13, 2020

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