Global Bank Review: Sustainable Lending – Are We There Yet?

This article is part of ours 2021 Global Bank Review – ESG: Shaping a Meaningful Future, an annual publication by our Global Banks Sector Group that brings our people together, the banks live and breathe.

Sustainability-related loans, which gradually offer price advantages to borrowers who meet set sustainability-related goals, have grown dramatically in popularity over the past 18 months, driven by the broader growth of ESG-driven finance. However, we are not yet at the point where they are mainstream options for all borrowers.

For example, the popularity of sustainability-related loans varies significantly by region. They are now commonplace in Europe, with 65% of the companies surveyed in our latest Corporate Debt and Treasury Report 2021 intending to include ESG features in their next financing, and 35% of those specifically looking at sustainable lending . By comparison, drawdown is far lower in Asia, where only experienced borrowers have the procedures and guidelines to tap this capital pool.

The two basic (and interrelated) characteristics of sustainable lending are:

  • the goals themselves, which are based on key performance indicators (KPIs); and
  • how the satisfaction with these is proven and checked.

Some KPIs that we see go beyond climate factors, although in sustainable lending they are almost always combined with an environmental target. Such benchmarks can be governance goals, such as diversity on the board of directors or helping customers to use resources wisely, or social goals, such as increasing donations for charitable purposes.

There are usually two to four KPIs that can be drawn from the entire ESG spectrum. The KPIs often refer to traditional key figures for reducing CO2 emissions and increasing the use of renewable energies and energy storage capacities. Third-party certifications can also be used to aid in comparability and evidence of objectivity; Projects, infrastructure and buildings have a number of external certifications that can, for example, assess the sustainability of the construction, performance and renovation requirements of this facility. At the company level, an improvement in a company’s sustainability rating could also be used to set sustainability goals.

Some KPIs that we see go beyond climate factors, although in sustainable lending they are almost always combined with an environmental target. Such benchmarks can be governance goals, such as diversity on the board of directors or helping customers to use resources wisely, or social goals, such as increasing donations for charitable purposes.

If a borrower already provides sustainability information in accordance with the recommendations of the Task Force on Climate-related Financial Disclosures (TFCD) or other established standards, KPIs can be closely aligned with the borrower’s sustainability strategy. A member of the consortium is usually appointed as a sustainability coordinator or structuring officer to help set KPIs that are acceptable to lenders and to ensure that the borrower’s goals are sufficiently tight to counter any allegations of greenwashing.

“The challenge will be to maintain the flexibility of sustainable credit products: Mark Carney, the former Governor of the Bank of England who has become a sustainable investment champion, has spoken of recognizing 50 shades of green when the economy hits net zero will.”

A breach of a sustainability goal would rarely be an explicit failure: Instead, control is largely based on reputational concerns at the lender and borrower level. Lender policies and eligibility criteria will largely determine which borrowers have access to sustainable loans and what loan terms are available. Lenders can carefully examine factors outside the narrow scope of the KPIs to reflect their own ESG guidelines in order to mitigate the risk of reputational damage, particularly with respect to social and governance factors, and this diligence can be reinforced with sustainability-related products.

In addition, lenders may need to report on their sustainability performance in their own investor notes or annual reports. It is crucial that loans marked as sustainable actually and objectively meet the relevant criteria. The verification of compliance by external experts or auditors is therefore a characteristic of many sustainable loans, especially when it comes to so-called “brown” industries.

50 shades of green, finally

Disclosures against TFCD recommendations are currently voluntary in most countries. However, the COP26 Private Finance Hub, an initiative to coordinate industry actions around this year’s UN Climate Change Conference, has cited improved reporting and the development of a strategy to broadly implement TCFD as part of its four main goals. Many larger European companies are already providing sustainability information on a voluntary basis in accordance with some TFCD benchmarks and preparing sustainability reports that can be verified by their auditors.

However, for companies that do not, the time and expense involved in creating suitable KPIs and demonstrating progress can be significant and more than outweigh the relatively small price advantage of a sustainable loan. The move to mandatory TFCD-style disclosures, another goal of the COP26 Private Finance Hub, will increase the availability of such verified information and align company policies more closely with established ESG credit guidelines, which should allow more borrowers to tap into this source of funding.

“It would be rare that a breach of a sustainability goal would be an explicit failure: Instead, control is largely based on reputational concerns at the lender and borrower level.”

The challenge will be to maintain the flexibility of sustainable credit products: Mark Carney, the former Governor of the Bank of England who has become the champion of sustainable investing, has talked about recognizing 50 shades of green when economies go to net zero. The much-vaunted EU taxonomy was developed as a classification system to help investors determine environmentally sound activities, but this is not an easy task for all businesses. The taxonomy is highly prescriptive and technical and has taken time to develop.

So far, the focus has been on the first two of the six core goals mentioned (climate change adaptation and mitigation), with some politically sensitive activities, such as nuclear power, being completely omitted. The UK intends to create its own taxonomy that could be more principled to avoid sinking into stagnant administrative standards, but taxonomies have inherent limitations and have been rejected elsewhere.

Various initiatives by governments and trade organizations aim to expand the circle of borrowers who have developed sustainability guidelines. It is noticeable, however, that there is a significant gap between borrowers who can access the trillions of dollars in ESG capital available around the world and those who do not. Despite the booming market for sustainable lending, there is still a long way to go before such loans are available to everyone.

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About Natalee Broderick

Natalee Broderick

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