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Corporate Loans Redesigned by Banks to Meet ESG Goals in Face of Regulatory Pressure

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Corporate loans that are tied to environmental, social, and governance (ESG) goals are undergoing a redesign by banks in response to increased regulatory pressure and a desire to enhance credibility in a growing market. Sustainability-linked loans (SLL), introduced in 2017, offer companies slightly cheaper borrowing rates if they meet specific targets, such as reducing carbon emissions or improving board diversity.

However, banks are faced with the challenge of implementing stricter standards without dampening demand for SLLs. Unlike loans tied to specific projects, SLLs allow borrowers to use the funds for any purpose and contribute towards lenders’ own sustainable finance commitments. This has led to concerns about greenwashing and reputational risks if borrowers fail to meet the set goals.

Reuters reviewed 14 major banks and found that JPMorgan was the only one that did not automatically include labeled loans and bonds in its sustainable finance targets. The market for SLLs has faced a decline in issuance, dropping by 36% to $310 billion so far in 2023 compared to $480 billion in 2022, according to data from the London Stock Exchange Group (LSEG). Although there have been significant SLL deals this year from companies such as German utility RWE, automaker Ford Motors, and French energy group Engie, issuance has still fallen.

The changing market landscape is evident in the recent SLL documentation signed by Engie, which includes “declassification” clauses allowing banks to remove the sustainability-linked label if targets are no longer deemed appropriate. The tightening standards implemented by banks have discouraged some borrowers from using SLLs altogether. Banks are also including penalties in SLLs, raising borrowing costs if companies fail to meet targets. They are broadening the definitions of a “sustainability amendment event” to include regulatory changes and shifts in business strategy that impact sustainability goals.

The Financial Conduct Authority (FCA) in the UK has expressed concerns regarding “market integrity” and potential conflicts of interest in relation to ESG financing targets. Banks have responded by introducing tougher measures, such as the right to remove the SLL label for severe controversies. Some lenders and lawyers are also considering clauses to trigger a default if a borrower fails to meet sustainability commitments.

The Loan Market Association based in London, alongside industry bodies in North America and Asia, has tightened guidelines for lenders structuring SLLs, signaling an improvement in standards. However, there is still a call for banks and borrowers to publish the sustainability elements of loans for public scrutiny.

While standards are being tightened, there are differing opinions on the value of sustainability-linked debt. Automaker BMW, for example, completed an 8 billion euro ($8.5 billion) revolving credit facility in June but opted against an SLL. Corporate finance director Fredrik Altmann believes that such debt does not adequately reflect what drives BMW and its investors.

Overall, banks are working to strike a balance between stricter standards and maintaining the appeal of SLLs. The focus is on injecting more credibility into the market while addressing concerns of greenwashing and reputational risks. As the regulatory landscape evolves, lenders and borrowers are considering new measures and clauses to ensure sustainability commitments are met.

More detail via Yahoo! Finance here… ( Image via Yahoo! Finance )

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