Latest developments in the investment grade sustainable lending market

In this blog post, we reflect on the rapid rise of sustainability linked loans (SLLs). We explore developments in SLLs covering how market participants quantify and measure environmental, social and governance (ESG) targets. We also consider the crossover of increasing influence of publicly available climate disclosures on borrowers’ financing strategies.

A continuing surge in SSLs

This week, with the launch of the 26th Conference of the Parties (COP26), public attention is focussed on the Paris Agreement goals, particularly the mobilisation of the finance industry to secure net zero by 2050. COP26 and the immediacy of the climate change crisis certainly helps to explain the continuing rise in ESG linked lending.

During the first half of 2021, we have seen unprecedented growth in ESG linked lending. Globally, research shows that ESG linked lending reached US$448 billion in the first nine months of the year, tripling the figure recorded in 2020 during that same period. The UK SLL market is also seeing significant growth (see the chart below).  

A reminder of the uses of SLLs

Unlike ‘green loans’, which require loan proceeds to be applied exclusively to finance new or existing green projects, SLLs do not carry restrictions on how the loan proceeds can be used. SLLs typically require the borrower to achieve certain pre-agreed sustainability targets in return for a reduction in margin payable on the loan. SLLs are suited for both term and revolving credit facilities and, as the data show, SSLs continue to be a popular choice among borrowers seeking financing for various corporate or treasury needs.

KPI developments in the SLL market

Key performance indicators (KPIs) are the cornerstone of SLLs, and are negotiated on a deal by deal basis with reference to the nature of a borrower’s business. Should the borrower meet the agreed KPIs, the margin payable on an SLL will typically be reduced. As the SLL market matures, we are seeing an increasing number of SLLs being arranged by sustainability coordinators or sustainability agents who help to select appropriate KPIs, ensure the targets selected are stretched, and streamline negotiation.

Whilst some SLLs still use borrower self-certification of KPIs, an increasing number of lenders now require independent review of a borrower’s KPIs. There is an associated cost for borrowers in agreeing to an independent review, but many are already reporting their ESG credentials either in their annual report or in a separate sustainability report, and the approach does allow borrowers to more clearly point to the success of their ESG policies. Borrowers have the choice to select a wide range of KPIs falling under the ESG banner, and we have seen a number of borrowers taking a blended approach to KPI targets. For example, this year a major telecommunications company entered into one of the UK’s largest SSLs and used a variety of KPIs including:

• the percentage of women in management and senior leadership roles;
• the number of customers with access to mobile money services (empowering marginalised rural societies by providing access to banking services); and
• a percentage reduction in CO2 emissions.

Developments in climate-related reporting 

A number of recent developments in climate related reporting have increased the pressure on borrowers to focus on sustainable operations. Most recently:

• On 29 October 2021, ahead of the COP26 summit the UK Treasury announced that it would enshrine into law a mandatory requirement for the UK’s largest companies to disclose climate-related risks and opportunities, in line with the Task Force on Climate-related Disclosures (TCFD) recommendations. The rules are set to come into force from 6 April 2022 and will apply to many of the UK’s largest traded companies, banks and insurers, as well as private companies with over 500 employees and £500 million in turnover. More information about the UK Government’s long-term sustainability agenda, which includes the phasing in of TCFD recommendations can be found here.
• Borrowers may face potential credit implications as a result of poor sustainability performance. ESG factors have started – indirectly – to feed into ratings awarded by mainstream rating agencies such as S&P Global, Moody’s and Fitch Ratings. For example, S&P Global, considering environmental risks among other factors, downgraded major oil and gas companies in its industry risk assessment from intermediate risk to moderately high risk.

Market transparency and more readily available data related to climate change will add to the pressure faced by investors and businesses to adopt sustainable strategies, and we expect this to lead to continued growth in the SLL market.

Further information

If you are interested in SLLs or in ESG financing more generally please do not hesitate to contact us, or your usual Freshfields Bruckhaus Deringer LLP contact.