LONDON/NEW YORK, Nov 10 (Reuters) – Corporate loans with costs linked to environmental, social and governance (ESG) objectives are being redesigned by banks in response to increasing regulatory pressure and to inject more credibility into a market they hope to grow .
Sustainability-linked lending (SLL), first introduced in 2017, offers slightly cheaper loans, typically around 2.5 to 10 basis points less, if companies meet goals such as reducing their carbon emissions or improving diversity of the board.
Banks must balance stricter standards without undermining demand for SLLs. Unlike loans tied to specific projects, borrowers can use the funds raised as they wish as they count towards the lenders’ own sustainable finance commitments.
“There is no more hype,” says Constance Chalchat, Chief Sustainability Officer of BNP Paribas Corporate and Institutional Banking. “Not being 100% bulletproof can cause greenwashing or reputational risks.”
Of the fourteen major banks reviewed by Reuters, JPMorgan (JPM.N) was the only one that did not automatically count loans and bonds towards its own sustainable finance target.
Amid increasing regulatory scrutiny and suggestions that SLLs allow companies to inflate their green credentials, LSEG data shows issuance has fallen 36% year to date to $310 billion in 2023, from $480 billion in 2022 Total loan volume also fell during the period, but by a less sharp 21%.
The decline is despite large SLL deals this year from returning borrowers such as German utility RWE (RWEG.DE), carmaker Ford Motors (FN) and French energy group Engie (ENGIE.PA).
In a sign of how the market is changing, an Engie spokesperson said the most recent documentation it had signed for SLLs, which LSEG data shows it agreed to cost $4.8 billion, contained “declassification” clauses.
This allows banks to remove the sustainability label from the loans if objectives are no longer considered appropriate.
The banks’ stricter standards are discouraging some borrowers from making full use of SLLs, bankers and lawyers told Reuters.
Others are first “taking a closer look at the structures,” says Pascale Forde Maurice, head of Credit Agricole CIB’s European Corporate – Sustainable Investment Banking department.
The British Financial Conduct Authority (FCA) warned about this in June “market integrity” concerns, including weak incentives, potential conflicts of interest and unambitious objectives.
The FCA said banks’ remuneration incentives to meet ESG financing targets may have created potential conflicts of interest, encouraging them to accept weak corporate targets.
Banks have responded by including more penalties in SLLs that increase financing costs if a company doesn’t meet its targets.
They also push for the right to remove the SLL label due to a “serious controversy,” and use untested language, such as that the company or its products have a “negative impact” on the borrower’s environment, social principles or the board, said Elliot. Baard, partner at Simmons & Simmons.
They also broaden the definition of a “sustainability change event,” which has traditionally been invoked when an acquisition or divestiture changed a company’s sustainability profile.
Beard said this extends to regulatory changes, shifts in business strategy and “any other event” that banks believe will have a material impact on sustainability goals.
“That would give lenders significant leeway to say, let’s go around the table and renegotiate… I haven’t seen that accepted yet, but that’s what some banks are pushing for,” he added.
Lenders and lawyers are also considering default trigger clauses, which require immediate repayment, if a borrower is deemed to have defaulted on its sustainability obligations.
Such a clause, which already appears in some private deals, “provides more teeth” but could deter more borrowers, said David Milligan, partner at Norton Rose Fulbright.
Engie’s spokesperson said the utility does not agree to link an event of default to sustainability goals.
The London-based Loan Market Association, which has tightened guidelines for lenders structuring SLLs along with industry bodies in North America and Asia, says standards are improving. Its head of sustainability Gemma Lawrence-Pardew said banks and borrowers must go further by publishing the sustainability elements of loans for public scrutiny.
Private lenders are also aiming to be stricter.
“We stated that we were willing to walk away if the sustainability targets were too soft,” said Brittany Agostino, vice president of the environmental, social and governance group at Los Angeles-based Ares.
“We request historical data on energy efficiency goals, and we have built in safeguards to ensure companies don’t use mergers and acquisitions (M&A) just to achieve them.”
However, some question the value of sustainability-related debt.
BMW (BMWG.DE) completed an 8 billion euro revolving credit facility in June, but unlike fellow automaker Porsche (PSHG_p.DE) decided against an SLL.
Corporate Finance Director Fredrik Altmann told Reuters that such debt serves BMW and its investors poorly.
“Our investors need to understand what drives BMW,” he said. “That won’t happen if one KPI (key performance indicator) or two KPIs decide whether a labeled transaction is green or not.”