Corporate loans tied to environmental, social, and governance (ESG) goals are undergoing redesign by banks in response to increasing regulatory pressure and to enhance credibility in a growing market. These sustainability-linked loans (SLL) were first introduced in 2017, offering slightly lower borrowing costs for companies that meet specific targets such as reducing carbon emissions or improving board diversity.
Banks face the challenge of implementing stricter standards without dampening demand for SLLs, as these loans contribute to lenders’ own sustainable finance commitments and allow borrowers flexibility in using the funds. Constance Chalchat, Chief Sustainability Officer for BNP Paribas Corporate and Institutional Banking, emphasized the need for credibility and warned against greenwashing or reputational risks.
A Reuters review of 14 major banks revealed that JPMorgan was the only one not automatically counting labeled loans and bonds towards its sustainable finance target. However, despite efforts to improve standards, data from the London Stock Exchange Group (LSEG) shows a 36% decrease in SLL issuance to $310 billion in 2023, compared to $480 billion in 2022. Total loan volumes also dropped, albeit by a lesser 21%.
Even with prominent SLL deals from repeat borrowers like RWE, Ford Motors, and Engie, the market is evolving. Engie’s recent SLL documentation, valued at $4.8 billion according to LSEG data, includes “declassification” clauses that allow banks to remove the sustainability-linked label if targets are no longer deemed appropriate.
Stricter bank standards are dissuading some borrowers from using SLLs altogether, while others are scrutinizing loan structures more closely. The Financial Conduct Authority (FCA) in the UK expressed concerns about market integrity, weak incentives, potential conflicts of interest, and unambitious goals in June 2023.
In response, banks are incorporating penalties in SLLs to increase borrowing costs if companies fail to meet targets, and they are reserving the right to remove the SLL label for severe controversies. Lenders are using language such as “adverse impact” on the environment, social principles, or governance to outline potential risks. Definitions of a “sustainability amendment event” are also expanding to include regulatory changes and business strategy shifts that significantly impact sustainability goals.
In addition to these measures, lenders and lawyers are considering default-triggering clauses that require immediate repayment if a borrower reneges on sustainability commitments. While this provides more enforceability, it may also discourage potential borrowers.
The Loan Market Association in London, along with industry bodies in North America and Asia, has tightened guidelines for structuring SLLs to improve standards. However, there is a call for greater transparency, with suggestions for banks and borrowers to publish the sustainability elements of loans for public scrutiny.
Private lenders are also aiming to be more rigorous in their evaluation. For instance, Los Angeles-based Ares has expressed its willingness to walk away from deals with soft sustainability targets. They request historical data on energy efficiency targets and implement safeguards to prevent companies from using mergers and acquisitions solely to meet these targets.
However, some question the value of sustainability-linked debt. BMW, for example, opted against an SLL when completing an 8 billion euro ($8.5 billion) revolving credit facility in June. The company’s Corporate Finance Director, Fredrik Altmann, stated that such debt does not effectively represent BMW and its investors, as relying on one or two key performance indicators to determine if a transaction is green may not adequately capture the company’s overall sustainability efforts.
While banks and lenders are taking steps to enhance the credibility and standards of sustainability-linked loans, there is still room for improvement. The market continues to evolve, and greater transparency and scrutiny are necessary to ensure the reliability and integrity of this growing sector.
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More detail via Reuters here… ( Image via Reuters )