What is the issue?

The number of companies arranging loan capital via ESG-linked financial instruments has grown dramatically in a relatively short period; notably since the publication of the Sustainability-Linked Loan Principles in 2019. The combined total of all green and sustainability-linked loans issued to date has passed the US$100 billion mark.

The recent good performance of investment funds invested based on ESG-related criteria during the COVID-19 pandemic has shone a brighter and more favourable light on financial instruments linked to ESG, drawing even more attention to this growing trend.[i]

Companies say they are looking for capital to build resilience across their organisational structure for inevitable future business/systemic shocks such as climate change and sustainability shifts. And they say the prospect of more avenues of capital would be welcome.[ii]

So how can companies with good ESG credentials, but not yet with a specific green or social project to point to, plan an approach to the markets for access to loan capital based on those strong sustainability scores? How does it work for companies that already do so?

The recognition of ESG as a strategic differentiator and risk barometer has been proved in the market, putting further pressure on companies to up their ESG game. Peer group comparison is never far away and a ‘best-in-class’ ESG label is highly desirable.[iii] Obtaining capital while demonstrating competitive advantage – and at favourable rates – is definitely a reputation builder.[iv] With 2030 – the year the UN Sustainable Development Goals – SDGs – are to be delivered – looming and reports that it will take US$ 5- 7 trillion per annum to fund them, the challenge is on for companies to understand sustainability-linked financial instruments and get involved.[v]The capital is available in the market for those able to access it, but what are the benefits, the risks, the terms, and the prospects for market growth and evolution?

Background: where did it all begin?

The permeation of ESG factors into financial instruments started pre-pandemic and is a trend that is here to stay. It began in 2008 when the first green bond was created and issued. In 2007, a group of Swedish pension funds wanted to invest in projects to help the climate, but they did not know how to find or fund them. They turned to the World Bank for assistance. The institution had a history in raising bonds (its first was issued in 1947), a wealth of knowledge of development projects and global financial reach. Less than a year later, the World Bank issued the first green bond creating the blueprint of today’s market, and paving the way for related financial instruments based on broader ESG criteria. Currently, renewable energy-related green bonds represent about half of the sector’s issuance.[vi] Further innovation in the green bond market has birthed other labels such as social bonds and blue bonds. Recently, COVID-19 recovery bonds have been issued. Banks such as HSBC have also issued SDG bonds.

What are the barriers for stakeholders and how is this market serving companies?

Despite the growth of the green bond market, challenges exist. They include a deficit of harmonized global standards, risks of greenwashing, the perception of higher costs for issuers, and the lack of supply for investors.[vii] Corporates have been active in issuing ESG linked bonds. Enel, the Italian oil major, is a good example. It was an early issuer of green bonds and became one of the largest. In 2019, it issued a broader ‘sustainability-linked’ bond.[viii] Other large established companies such as Alphabet, BASF, Orange, PepsiCo and Phillips are active in sustainability-linked bonds and their participation is enabling and funding new, regenerative business models in the circular economy.[ix] Sustainable development is clearly developing as a result, but is this activity focused in just a few areas, and is the opportunity only available for the “large green giants? For companies with strong ESG credentials and no identifiable projects, where is the opportunity to get involved?

What is the sustainability-linked loan rationale for companies?

The rise of sustainability-linked (or ESG-linked) loans has been a game changer. In short, they are general corporate purpose loans used to incentivize borrowers’ commitment to sustainability and to support environmentally and socially sustainable economic activity and growth. Previously referred to as positive-incentive loans, the instruments are linked to the ESG indices and ratings of a data provider. Correlation between a high ESG rating and favourable cost of capital incentivises companies to improve their sustainability performance.[x] Last year, the issuance of sustainability loans (which includes social as well as green loans) jumped 168 percent to $122 billion.

Some examples:

  • In February 2020, JetBlue Airways became the first airline to deploy a sustainability-linked loan deal with BNP Paribas. The company amended an existing $550 million line of credit to link to the airline’s ESG score as calculated by Vigeo Eiris, a provider of ESG research and services.[xi]
  • Cofco International, one of China’s largest food companies and Mitr Phol, the Thai sugar producer, sourced sustainability-linked loans in response to the pandemic.[xii]
  • Polymetal International, a Russian precious metals mining group, partnered with ING Bank to convert an existing bilateral credit facility of US$ 80 million with the bank into a sustainability performance-linked loan.[xiii]

What is the investor view?

For investors, corporate take up of ESG-related instruments can build reputation and demonstrate work towards a more sustainable future. Investors themselves are under pressure to decarbonise their investment portfolios and demonstrate to their asset owners that their products are credible in terms of their ESG credentials. It is clearly important to avoid “greenwashing”, a term coined by the environmentalist Jay Westerveld in 1986.[xiv]

Companies can brand themselves as associated with sustainable practices and products, but the authenticity of these claims must be known and understood. There is, however, visibility for investors through reporting and disclosure. The Loan Market Association (LMA) is responsible for setting a voluntary framework for the majority of the ESG instruments mentioned in this paper. For example, the Green Bond principles govern and offer best practice approach to transparency and disclosure.[xv] Receivers of loan proceeds are obliged to clearly communicate their environmental objectives and follow mandatory reporting on the capital expenditure (use of proceeds). In the case of sustainability-linked loans, third-party ESG ratings oversee transparency and accountability. This has been bolstered by the LMA who issued the Sustainability-Linked Loans Principles in 2019.[xvi] With investors firmly onboard, there is little excuse for companies not to step up.

What does this all mean for companies?

Work to achieve high ESG ratings and indices may be rewarded. Companies who do well in ESG indices and ratings will have access to ESG-linked capital, which may present more favourable terms. There are big questions though. How difficult is it to access this capital? What hoops do companies need to jump through? What internal and external resources are needed? The upskilling of finance teams in order to take advantage of available funds for sustainability projects will be an important factor moving forward. The involvement of “non-financial executives” will be key to running programmes that deliver. The complexity of sustainability factors against siloed corporate structures will need solid internal governance able to span the company’s expertise at various levels up to the board level. It will also need a clear understanding within the organisation of the nexus of finance, sustainability, business strategy and execution, company commitment and reputation.

related webinars

ESG and Financial Instruments: Case study on the new wave of sustainability-linked loans

Feb. 2021 | Dear Company, the fruits of your hard labour to achieve high ESG ratings and index placings will be rewarded with capital on favourable terms. And your green projects can be clearly financed through the capital markets in green bonds and related products.
In this webinar you find out how.

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