Environmental, social and governance issues are becoming increasingly important to businesses as they have become more aware that the potential for long-term success depends on the risks of sustainability. This is a consequence of regulatory and political factors, but also of changing demands from various stakeholders such as investors, consumers and employees.
It is estimated that Europe needs € 290 billion in additional annual investment to meet the targets set by the Paris Agreement. While the EU has committed over € 1 trillion in public funding for sustainable investments under the European Green Deal, given the scale of the investment gap, this will need to be complemented by private investments. UN Special Envoy for Climate Action and Finance Mark Carney put particular emphasis on the need to channel private investment towards sustainable goals and for banks to hedge against climate-related risks on their books. of loans.
Sustainable loans, integrating green loans and sustainability-linked loans, as well as other forms of sustainable finance such as impact investing and green bonds, enable a wide range of borrowers and lenders to ” integrate sustainability into their funding models. As a result, these types of loans have become increasingly popular in recent years – the global value of green and sustainability-related loans in 2019 is estimated to be US $ 163 billion.
Sustainable development loans and green loans
Sustainability loans are any type of lending instrument and / or conditional facility that incentivizes the borrower to achieve ambitious and predetermined sustainability performance goals. On the other hand, green loans are any type of loan instrument made available exclusively to finance or refinance, in whole or in part, new and / or existing eligible green projects.
The rapid development of these types of loans was supported by the introduction in 2018 of the Principles for Sustainable Development Lending (SLLP) and the principles of green loan (GLP). The SLLPs and BPLs were updated in July of this year and provide a framework for the implementation of an increasingly important area of funding. These are only guidelines given the wide range of transactions for which they are intended and do not require specific wording.
BPL vs SLLP
GLP takes a goal-oriented approach. The determining factor for this type of loan is how the loan proceeds are to be used. As a result, they will not be suitable for loans outside of certain prescribed categories of “green projects”, for example construction of a renewable energy project or infrastructure for clean energy vehicles.
In contrast, SLLPs focus on performance incentives and are therefore quite flexible in their potential application. The application of the loan proceeds is not a determining factor for these types of loans and therefore these are generally used for general business purposes. Sustainability loans can be used for all types and sizes of financing. They can also be used as part of a larger financing arrangement, for example for the working capital portion of a facility.
The borrower and its lenders will agree on a set of sustainability performance goals (SPT) that are both ambitious and meaningful, while being relevant to the CSR strategy of that borrower. The borrower is incentivized by a margin ratchet – if he is successful in meeting his goals, he will benefit from reduced pricing. However, if they do not meet their goals, there may also be an increase or penalty.
Both parties should be committed to achieving the real goal of sustainability rather than obtaining direct financial gain. Neither the borrower nor its lenders should benefit financially from achieving or failing to meet SPTs and the proceeds of an increase or decrease should be channeled and released back into circulation for agreed sustainability purposes.
Various global brands are looking to sustainability related loans to support their sustainability philosophy. As an example, plant-based milk producer Oatly took out a SEK 1.925 billion sustainability loan earlier this year and entered into 4 key SPTs with its lenders – reducing water consumption, improving l ” energy efficiency, introduction of electronic vehicles and avoidance of CO2 emissions. However, SPTs will be specific to the borrower’s business in particular – and could be something as simple as improving the energy efficiency of properties owned or leased by the borrower.
One of the main objectives of SLLPs and BPLs is to avoid “greenwashing” or “sustainable development”. Ongoing reports and reviews, often by a specialized third party, are an integral part of both sets of principles.
Legal, regulatory and other incentives
While SLLPs and BPLs are not intended to directly facilitate financial gains, other factors may prompt borrowers and their lenders to adopt these types of loans.
The European Parliament adopted the Taxonomy Regulation earlier this year, which aims to establish an EU-side classification system so that investors and businesses can assess how environmentally sustainable economic activities are. The European Parliament also adopted the Disclosure Regulation, which aims to ensure that financial market participants take into account sustainability risks and impacts and disclose them to investors.
Regulators such as the European Central Bank (BCE) and the Central Bank of Ireland (CBI) indicated that this area will become an increasing priority. The ECB published a consultation in which it said it will require banks to be more transparent in their disclosures on these matters and that it will require banks to include these factors in their risk assessments, with similar intentions shared by the CBI as part of their oversight role.
In addition to the regulatory focus on sustainability, which banks will in turn demand from their corporate clients, banks and businesses are also expected to come under pressure from investors to take more sustainable approaches to their lending portfolios and of their business models. Banks, in particular, are under pressure to deleverage certain categories of loans such as those related to fossil fuels from their balance sheets. One example is the resolution tabled by some of Barclays’ largest institutional investors requiring them to publish a plan to phase out loans to certain companies that are not aligned with the targets set in the Paris Agreement.
Finally, the growing consumer demand for sustainable products and brands with a sustainable philosophy will also prompt changes in funding arrangements.
While green loans will suit a very particular type of borrower purpose, sustainability-linked loans present opportunities for borrowers and lenders beyond the green sector to introduce sustainability into their financing arrangements. With the wide range of SPTs that can be supported under a sustainability linked loan, borrowers will have the opportunity to focus on goals that are both relevant and important to their particular business, so that they can meet their needs. growing demand from their stakeholders to demonstrate their sustainability profile.