Monday 16 April 2018

A new generation of sustainability-linked loans is reshaping the market, putting more companies' green goals within reach.


Green lending is transforming today's financial landscape, providing funding to a wide range of corporates and incentivising business to build a more sustainable future and it is continuing to gain traction.

It is widely recognised by organisations such as the UN that the private sector must step up to help reduce the "emissions gap".  The corporate sustainable lending sector is set to play a critical role in financing the transformation to a low carbon economy. Although still only a fraction of the estimated USD 66,550 billion lent to non-financial sector corporates globally in 2017, there is growing appetite for sustainable lending in the corporate  and finance communities. Despite challenges regarding regulation and standards, developing this sector will free up finance to a host of firms.

Companies currently have two main green financing options. The first is the "green bond", used to
"The corporate sustainable lending sector is set to play a critical role in financing the transformation to a low carbon economy"
finance green projects. There were USD 895 billion green bonds in circulation 1 by the end of 2017, meaning issuance would have to rise sixfold to fuel the global upgrade pipeline, according to data from the Climate Bond Initiative.

Not all companies can or want to issue debt securities, or have specific projects to finance. This is where the second option, green lending, may help. Through "sustainability-linked loans" or "positive impact loans", borrowers can access general liquidity lending with terms linked to corporate progress on sustainability.

The green lending market is small but growing fast. Cecile Moitry, Director of Sustainable Finance and Investment at BNP Paribas Corporate and Institutional Banking (CIB), says last year's total volume of EUR4.5 billion of syndicated loans was surpassed by the middle of February this year.

Holistic Sustainability Assessment

Many early green loan structures proved too rigid.

"The tipping point was to switch from linking loans to individual projects to evaluating the company itself. That opened the market to a broader universe of corporates which already have a sustainability strategy in place"
Cecile Moitry, Director of Sustainable Finance and Investment at BNP Paribas CIB

Today's green loans are more holistic. Companies are typically offered "standard" pricing, built around normal risk and credit parameters. Specific key performance indicators (KPIs) are then added to the loan contract. Companies receive a discount as targets are reached. If targets are missed, they pay a premium.

Performance is reviewed by a third party organisation and such loans are open to companies of sufficient size and financing requirements, providing they have suitable corporate social responsibility policies in place.

"The target to trigger the discount is quite significant; it is not a small thing. It requires an effort," says Moitry.

In October last year, Belgium's mail service Bpost agreed the country's first sustainability-linked loan, signing a EUR300 million borrowing facility deal with a syndicate of four banks including BNP Paribas, which ties loan terms to the company's overall sustainability achievements.

Then in December, BNP Paribas was part of another syndicate that agreed a EUR600 million revolving credit facility with Finnish renewable paper and packaging manufacturer Stora Enso.
The company was the first in its sector to integrate greenhouse gas emission targets for its operations, suppliers and downstream transport providers. It aims to cut its own emissions by 31% by 2030.

The terms of the deal are directly linked to the company's success in cutting its own emissions and other sustainability goals, such as encouraging suppliers to set ESG targets. Stora Enso has committed to having 70% of its non-fibre and downstream transportation suppliers set their own GHG reduction targets by 2025.

Differentiation on Sustainability

Stora Enso Senior Vice President and Head of Group Treasury Martin Ros hopes the deal will set a precedent.

"We want to work with partners, including our banks, who are sustainable too," he says.

"It is about differentiation on sustainability. We want other, non-financial metrics to be part of the pricing. It is also a two-way street. If your company does not adjust to a low carbon economy, financing should be more expensive," he says.

Ros wants to take the concept further, building in other targets, such as worker welfare, across more financing products. One day, sustainability should be an integral part of all credit risk assessments, he thinks.

In February this year, BNP Paribas also acted as a sustainability coordinator for the refinancing of a EUR2 billion revolving syndicated credit facility with food and drinks supplier Danone. The credit facility directly ties Danone's ESG performance to the loan pricing so that the company will receive a discount when outperforming or a premium when underperforming on its sustainability goals.

The switch in focus to linking terms to a borrower's overall sustainability efforts is welcomed by debt and capital specialist Jon Williams, Partner at PwC's Sustainability and Climate Change division.

"I would really like to see credit and green ratings integrated so I can see all the factors, with the green risk alongside the operational and management risks," says Williams.

Regulators are playing their part in encouraging greater transparency and evaluation of corporate sustainability. Brazilian listed companies have had to "disclose or explain" for many years. France is now following suit, with new disclosure requirements on energy transition.

At present, Williams says there is little empirical evidence to suggest that green lending criteria lead to lower risk. Policymakers have therefore resisted suggestions to introduce "green supporting factors" which lower capital requirements for banks' sustainable lending programmes.

Carrot and stick regulation

A recent report by Dutch regulator De Nederlandsche Bank warns of bubbles if regulation and oversight are not constructed correctly. Maarten Vleeschhouwer and Henk Jan Reinders, two of its authors, are looking at how green criteria can be incorporated into oversight frameworks.

"We need to disentangle the risk components. If it can be shown that 'brown' [i.e. carbon intensive] is higher risk, then it should be penalised. But should prudential policy be used to encourage green by cutting capital requirements? No, we think supervisory frameworks should remain fully risk-based," says Henk Jan Reinders.

Maarten Vleeschhouwer also points out that green supporting factors would lower the aggregate capital in Europe's banking system. Brown penalising factors would do the opposite, making the banking system more resilient.

There are other non-regulatory ways to encourage green lending, says Careen Abb, leader of the UN's Positive Impact Finance initiative. A white paper is due in April to explain how governments, public bodies, borrowers, investors and bankers can work more closely on business models and financing structures.

Abb gives the example of a town wanting to switch to LED street lighting. The project could deliver lower emissions but comes with big up-front costs. If the financiers, council and contractors work together before a deal is signed, they could install electric-vehicle charging points to the lampposts too, ensuring the project generates revenues to mitigate part of the cost.

"Banks can differentiate themselves by their ability to engage and advise their clients on developing impact-based business – in which positive impacts are not an externality but central to the business model itself," says Abb.

Regulation – by carrot or stick – can also help spread a more sustainable financing culture, she thinks. But it cannot solve the financing gap alone. She suggests lenders take a longer, strategic view, always keeping the "impact" considerations front of mind as they develop new green lending lines.


[1] - Climate Bond Initiative

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