The sustainability-linked loan is another product making rapid inroads into the sustainable finance landscape. Why now, and what are the prospects?
What is a sustainability-linked loan?Previously known as a positive-incentive loan (PIL), the sustainability-linked loan (SLL) is similar to other revolving credit facilities – a type of corporate loan – with the difference being the interest paid by the borrower. This interest is linked to selected sustainability key performance indicators (KPI), which can be, for example, carbon emissions or a more generic ESG (environmental, social and governance) target. Companies that achieve their sustainability targets benefit from favourable interest rates, while a failure to do so will lead to higher rates. With SLLs companies therefore have an incentive to align both financing and sustainability objectives.
Who are sustainability-linked loans for?What kind of company might consider a sustainability-linked loan? And how tangible could the KPI targets be? Any target that is suitable for a given company's sustainability objectives can be worked into the loan, meaning that it can be an approach specific to the borrower – or it can be linked to an existing sustainability rating.
Phillips became the first company to borrow though an SLL in 2017, whose interest on its €1 billion loan was linked to an ESG rating from Sustainalytics, an independent ratings firm. Others followed from a variety of sectors. BNP Paribas-led SLLs include:
- Chemicals: Belgian chemical company Solvay's €2 billion SLL was the first to link to an ambitious greenhouse gas reduction target – in this case one million tonnes of CO2 by 2025
- Utilities: Thames Water, a UK utility company, completed a £1.4bn SLL, the first ever corporate to link its borrowing to the GRESB Infrastructure Score, an ESG benchmark for infrastructure assets
- Hotels & Hospitality: Accor Hotels completed a €1.2 billion SLL tied to its Sustainalytics sustainability performance
- Education: Pearson became the first ever education company to tie its SLL to education targets, such as the number of people educated through their learning programmes.
- Housing: L&Q became the first UK housing association to borrow
through an SLL linking to employment targets, soon followed by Optivo.
Breaking down the siloesPutting in place an SLL requires an open and collaborative process between the treasury and sustainability departments to choose a KPI. Given the dual corporate objectives, in many cases the SLL allows the borrower to set a new benchmark in driving forward sustainable finance as a whole. This shift away from the pure funding objectives of borrowers to funding objectives that incorporate a positive impact underlines the possibilities of finance – namely, a corporate financing toolbox that can create the right incentive structure aligned with companies' long-term goals.
How big is the sustainability-linked loan market?The global SLL market grew from $5 billion in 2017 to $40 billion in 2018, according to Environmental Finance data, an eightfold increase.
" For any business today looking at achieving the UN SDGs, the corporate financing marketplace has rarely looked more exciting "Banks are becoming increasingly attuned to their role of financing companies in a more sustainable way and with a longer-term view, helping borrowers that have incorporated the UN Sustainable Development Goals (SDGs) achieve their objectives.
BNP Paribas has been particularly active in supporting corporates in the SLL market. Cécile Moitry, Head of Sustainable Finance at BNP Paribas CIB Company Engagement, notes: "We have seen a strong demand for SLLs in EMEA and it is BNP Paribas' mission to accompany our clients in their sustainability transition." Noting the expectation of further growth in all regions and new types of borrower, such as leveraged loan SLLs, "social and circular economy themes are growing concerns for the corporates, so they are often looking for topic targets that can be embedded into their sustainable financing strategy."( Hear more from Cecile about SLLs in her BFM Business interview.)
What factors are supporting the growth of sustainability-linked loans?In the first half of 2019, the Loan Markets Association (LMA) created the Sustainability-Linked Loans Principles, following the Green Loan Principles published in April 2018. Developed by a working group of financial institutions, including BNP Paribas, the LMA's Principles aimed to promote, through the development of the product and the market best practice, the development of sustainable finance more generally – and are a recognition of its growing importance. In turn, these frameworks will be vital in supporting the growth of SLLs and other sustainable financing instruments.
The key difference between SLLs and green loans relates to the use of proceeds: those in SLLs can be used for general corporate financing but with the interest tied to sustainability KPIs, while those from green loans must be targeted at specific projects (with the rate of interest not contingent on any sustainability metric.