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9 May 2024
Insight
Sustainable Finance as a percentage of new debt/refinancings
- Sustainable finance seems significantly less popular than it was in 2023, which was already less than at the peak of the market in 2021/2022. This mirrors the downward trend flagged in the 2023 edition of this report and general market sentiment in the second half of 2023.
- While ESG and sustainability remain a central element of corporates' strategies, many businesses are reluctant to agree separate sustainability performance targets in their debt financings.
- Many corporates prefer lenders to take a more holistic approach to their sustainability strategies in their credit discussions. This is in contrast to the forensic approach required for specific "labelled" sustainable finance products (where either the proceeds of the loan must be used to fund specific eligible green projects (a green, use-of-proceeds loan), or specific sustainability performance targets must be identified and there is a small pricing adjustment if those targets are attained (sustainability-linked loans, or SLLs)).
- We discuss common concerns with SLLs, in particular, in section 4.3. However, in contrast, the commentary suggested that there are some corporates who would see entry into new debt arrangements without specific sustainability features (whether larger syndicated loans or bonds) as inconceivable, which demonstrates that there is still a degree of variation in the market. Much of this divergence seemed to depend on whether a corporate already had sustainable finance in place or not. Those who are able to grandfather existing terms typically have a much easier time negotiating terms than those starting afresh due to the continued evolution in approach and terms.
- The commentary overall reinforces the view of sustainability-linked loans, in particular, as a transition product and that SLLs may soon become the first (relatively short) stage to have passed in the evolution of how debt providers drive sustainability.
- There is evidence that some early-adopter corporates who included specific sustainability features in their last round of loan financings in 2020/2021 feel that that specific sustainability-linked loans are no longer necessary. Some have removed specific sustainability-linked loan provisions from their revolving credit facilities when they recently refinanced.
- Others are more reluctant to actively remove the sustainability-linked features (or are reluctant to enter into a sustainability-linked loan in the first place) in case subsequently reverting to a financing without sustainability provisions were to be perceived less favourably by investors, with one interviewee commenting "can you back out of it now? Would it send the wrong message? But it's more and more of a headache".
- A view was also expressed that lenders are content not to label loans as sustainability-linked. For banks, sustainability is becoming part of the overreaching financing approval process; rather than seeking to drive improvement it is becoming a more binary: a lend/don’t lend decision.
- There remains strong appetite for sustainable bonds, particularly use-of-proceeds bonds, among some corporates. In some sectors there is also interest in the issuance of blue bonds at a corporate level (where the proceeds may be used for financing water supply or sanitation, offshore renewable energy production or sustainable shipping and port logistics, for example). However, one interviewee from a corporate with a sustainability-linked loan and a heavy focus on sustainability said that they were concerned about the difficulty of explaining meaningful sustainability performance targets for that business to investors, and that had so far dissuaded them from issuing a sustainable bond of that type.
- The very low appetite for sustainable finance in non-bank lending appears to be a feature of a lower take-up of those types of debt arrangements more generally by corporates.
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"In 2021 it [sustainable finance] was really in vogue…how could you not do it? A few years on far fewer are doing so." "It's no longer important to have the ESG badge on corporate funding." "The sustainability agenda is embedded in what the business is doing, which is a much more compelling argument to judge whether the company is following a sustainable business strategy than looking to an SLL." "When we have been speaking to banks they have said if you decide not to do an SLL we don’t mind, it's a lot of work and not driving how we look at you as a sustainable business." "Despite the RCF KPIs reflecting group strategy, banks were insisting the targets were not challenging enough and the RCF shouldn't be impacting the group's strategy." "When you have done so much on ESG and sustainability, you appear to be punished by the banks [by] the incremental ESG targets that you need to fulfil for the ESG loan [in contrast to] if you had done very little on ESG and sustainability." "We do a lot on ESG but may not tick the banks' boxes." "The underlying deals have to be ESG positive in any case." |
What impact do you expect ESG to have on your financing strategy in the next 12 months?
- The fact that almost half of respondents do not see ESG impacting on their financing arrangements at all is perhaps the strongest bellwether to date that corporate treasury is less now a key driver in a corporate's sustainability journey.
- Another 24% do not foresee considering a sustainable finance product in the next 12 months. Together these points suggest that there will be muted debut SLLs/bond issuance and that future issuance in the short term at least will be be largely confined to those with existing sustainable financing arrangements in place. Anecdotally we see significant evidence of this and many treasurers breathing a sigh of relief as a result.
- The growth of sustainability teams has also lightened the burden on treasury, many treasurers previously finding themselves at the heart of developing ESG frameworks precipitated by financing timetables.
- There was also some sentiment that debt providers had been seen to be pushing corporate sustainability targets beyond a corporate's published framework either due to the targets requested or suggesting alternative KPIs thereby creating additional complexity in discussions between treasury and ESG teams which this had resulted in some treasurers putting an SLL to one side.
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"Companies are just getting on with it; financing does not change what they do [on ESG]." "Our ESG guy looks 20 years older than he is due to all of the regulation coming down the track." "Investors want a clear sustainability narrative and to ensure that their sustainability strategy is aligned to their core values regardless of the ESG product label." "We intended to have a sustainability-linked bank loan but the administrative burden was far greater than the interest rate savings [so] we decided not to pursue this option." "We need to balance adding more complexity to our funding arrangements with the financial effect." |
What is inhibiting a greater adoption of sustainable finance products?
- As the graphic illustrates, a number of widely held concerns emerged from respondents:
- in particular, the additional verification requirements which lenders and other debt providers are imposing was a worry. The percentage of respondents who are concerned about this has risen significantly from 10% in 2022 and 2023 to 59% in 2024.
- The requirements for various forms of external review have increased in complexity markedly since 2021. They are now multifarious and include second-party opinions and various levels of verification. This seems to be driven by a desire to align with the ICMA 2022 Guidelines for Green, Social, Sustainability and Sustainability-Linked Bonds External Reviews. However the public bond market and the private syndicated corporate loan market are quite different and close alignment of the requirements for the two is not always appropriate.
- The minimal pricing changes for achievement of the targets in an SLL are not sufficient to offset the cost of this process, with one interviewee from a corporate with a strong focus on sustainability saying that they saw "no need to add extra complications or audit requirements into the bank facility".
- Lenders' concerns about greenwashing can lead them to seek sustainability performance targets that deviate from the corporate's own sustainability strategy (interviewees from corporates with developed sustainability strategies were concerned that lenders were seeking to "lead the group ESG strategy" and that the "RCF shouldn't be impacting the group's [ESG] policy").
- The complexity of SLL and sustainable finance contractual provisions has also added cost and delay into financing processes at a point in the economic cycle where there is the most acute focus on both. For some respondents the desire to pursue sustainable finance was muted by these factors and a desire to wait until the market had settled on terms before reconsidering sustainable finance.
- In addition, the cost and administrative burden of updating the targets through the life of the loan as the business evolves may well not be sufficiently compensated either by the loan being labelled as "sustainability-linked" or by the small pricing differential.
- Finally, respondents raising debt in the US also pointed to the difference between the US market, where sustainable finance products are less of a feature, and the European market, where they are more popular.
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