Under pressure from shareholder, investor and customer groups, you may have already included green initiatives in your business plan, and you have probably already identified the risks associated with climate change and other social and environmental factors. Is there a way to capitalize on what you are already doing by gaining access to the growing market for sustainability-linked loans (sometimes called ESG-linked loans)? Here we will refer to these loans as resilience linked loans or SLLs.
What is sustainability credit? Is this the same as green credit?
The green loan is structured like a typical loan, with the only difference that the proceeds from the green loan must be used for specific environmental or sustainable development initiatives. In contrast, a sustainability loan can be used for any general business purpose, but provides the borrower with a better price if it meets certain sustainability metrics. Because there is a lot of flexibility in the use of proceeds, these SLLs are more affordable for most companies than green loans, especially for companies that already track and address environmental, social and governance (ESG) criteria. As a result, along with the increased attention of politicians and investors to environmental initiatives, the market for these loans is growing rapidly. Bloomberg News It was recently reported that $ 52 billion in sustainability-related loans were funded in the US market between January 1 and May 21 of this year, nearly three times the amount of all such loans funded in 2020. Experts expect the SLL market to only grow from here.
How are ESG scores measured in sustainability-related loans and is it expensive to comply?
In terms of documentation, sustainability-related loan agreements can be drafted with slight differences from a traditional loan agreement. A key feature of the SLL is that certain specific ESG indicators lower the borrower’s interest margin (just as some loan agreements allow for lower margins when the borrower’s leverage ratio decreases). There are also additional reporting requirements, usually including providing lenders with a sustainability report on an annual basis detailing the company’s performance against selected ESG KPIs.
When it comes to tracking ESG performance, while there are many independent agencies offering ESG rating services, the market leader is the Sustainability Accounting Standards Board (SASB). The Loan and Trade Syndicates Association (LSTA), which is a trade organization in the loan market, has adopted the SASB’s performance in its ESG Due Diligence Request Listwhich he encourages all investors to request in connection with any loan granting process. SASB standards are narrowly tailored to the borrower’s industry, highlighting ESG KPIs that are reliably quantifiable and externally verifiable. SASB has created an affordable and convenient “Map of materiality” which sets specific ESG KPIs for any particular business. Because metrics are industry-specific and easy to quantify, they are often KPIs that companies already track for annual reports, presentations to lenders, or perhaps even self-sustainability reports. Ideally, borrowers can use the data they already collect to improve the pricing of their sustainability-related loans.
LSTA latest guide recommends that SLLs include third-party input in the selection of ESG KPIs and third-party monitoring and validation of these KPIs. While this approach potentially increases associated costs, standardization of requirements and the use of expert guidance will improve the efficiency of loan documentation and ongoing loan administration. An additional benefit for some borrowers will be that this approach will align the loan market requirements for monitoring the bond market linked to sustainability, which makes it easier to refinance a company from one market to another.
If my company does not receive a sustainability loan, do we need to be concerned about ESG disclosures?
As SLLs become more prevalent, investors are increasingly awaiting ESG disclosures in connection with traditional lending arrangements. As mentioned above, LSTA has prepared an ESG Due Diligence Questionnaire (ESG DDQ) form in which investors are encouraged to require borrowers to complete and submit data to the public room in connection with any due diligence process. ESG DDQ asks the company about its ESG-related policies and procedures and links to SASB Materiality Map… Increasingly, investors view ESG risk as a significant factor in their overall credit analysis for any borrower in any industry. Thus, borrowers can expect to see ESG-related due diligence requests whether or not they enter the sustainable loan market.
In addition, rating agencies are beginning to take ESG risk into account in their ratings process. Rating agencies have recently revised their ratings on several oil and gas companies to reflect business climate risks. A downgrade in a credit rating may increase the cost of borrowing for the issuer.
Given this reality, it might be a good time to explore access to this growing source of additional debt financing.