A Sustainability Linked Loan (SLL) is a credit facility that offers companies a discounted rate if they can meet the Sustainability Performance Targets (SPT) detailed within their issuance. The terms of these loans are not tied to the use of proceeds, nor the projects funded, they are exclusively concerned with the borrower’s ESG related performance, providing a great opportunity to utilise the loan within a general business. As a result of this malleable policy, SLLs have become popular substitutes for more traditional methods of raising capital and debt such as Green Loans and Bonds, as they provide a more suitable option for a variety of sectors. Green bonds were established in global markets in 2007 and whilst they work in the same way as a bond: they are produced to fund specific environmentally-friendly schemes. In December 2020, their issuance exceeded 1 trillion USD. Green loans are similar, in that they are based on loans in which the use of proceeds is directed toward projects or assets that combat climate change and environmental harm.
Over the past year, SLL uptake has continued to grow within Europe alongside renewed demand in North America, as companies begin to implement this alternative to regular ESG debt. As a result, the demand for SLLs has transcended that of green loans and bonds. According to the Bank of America, whilst issuance only reached 197 billion USD in 2020, it surpassed 350 billion USD in the first six months of 2021. This is in stark contrast to the success of green loans and green bonds in the first 6 months of 2021, posting stagnant issuance figures of 42 billion USD and 202 billion USD respectively. Moreover, the popularity of sustainability linked financings has been so great that the first half of 2021 saw 40% of European leveraged loans contain ESG margin ratchets, with this figure only increasing since.
This change comes as a result of the increasing requirement for corporate institutions to fulfil ESG objectives associated with their financial plans. Investment into carbon-heavy industries has been a growing concern for governments and regulators, therefore SLLs are becoming particularly attractive to sectors that are not traditionally green. Their flexible nature allows for much wider application. SLLs allow firms to focus on the ‘social’ and ‘governance’ aspects of ESG metrics as much as the far more topical ‘Environmental’ aspects. Oil and Gas Supermajor, Royal Dutch Shell PLC signed one of the largest SLLs to date in 2019, implementing an innovative 10 billion USD sustainability-linked credit facility. Both its fees and interest were determined by the company’s success in reducing its carbon footprint.
However, whilst this flexibility has driven market acceleration of the product, it has also led to fears of an increased potential for ‘greenwashing’. Greenwashing is when a company obfuscates its ESG performance to obtain better terms, and in this context, some companies have obtained SLLs containing SPTs that are far too easily achievable. These companies can benefit from the façade of green credentials, whilst undermining them in reality.
Having reflected on SSL market trends since its emergence in March 2019, the Asia Pacific Loan Market Association, Loan Market Association, and Loan Syndications and Trading Association published a revised version of the Sustainability Linked Loan Principles in May 2021. The amendments primarily detailed an increase in clarity and integrity for this credit facility type. Clarification of the terminology used within key performance indicators and SPTs provided greater transparency for what is expected of those entering the SLL market. Previously, the KPIs for the first few SLLs were often based on a company’s overall ESG rating. These changes mean that KPIs are more specific and necessitate third-party verification of their progress.
In October 2021, Baring Private Equity Asia (BPEA) obtained Asia’s largest SLL acquired by a private equity firm, at 3.2 billion USD. It comprises several ambitious ESG targets that will incentivise the firm to achieve higher ESG standards. BPEA has formally agreed that its portfolio companies will provide a more supportive environment for females in the sector, alongside a reduction of greenhouse gas emissions and improved transparency. The firm has also set an SPT implementing ESG risk and opportunity assessments, tailoring a clear strategy for each of its portfolio companies. This epitomises the new drive toward SLLs as a means of raising capital, demonstrating the effective integration of the latest SSLPs and raising standards within the market.
Many companies have not utilised SLLs due to underdeveloped ESG agendas or a lack of confidence in adhering to these ambitious targets. However, as the loan market integrates sustainability into its practice, more and more corporate credit facilities will contain ESG adjustments. The future of lending is in sustainability linked finance and this will be fundamental in encouraging both short and long-term thinking about crucial issues within the ESG sector.
By Henry Bagshaw
Sector Head: Philipp Jiang