Although relatively new to the field of sustainable finance, Sustainable Development Loans (SLLs) are gaining more and more attention from companies looking to strengthen their environmental, social and governance (ESG) profile.
SLLs offer flexibility and the potential for real economic benefits and positive ESG changes, and we are seeing a slight increase in SLL funding both nationally and internationally. But with opportunity comes responsibility, and there are a lot of things borrowers and treasurers need to consider to ensure that SLLs can be organized, executed and managed successfully.
With a general movement towards social responsibility becoming the goal of investors, shareholders and financiers, and in particular the target year of net zero emissions of 2050 on the horizon, we are seeing significant growth in sustainable finance at worldwide. The dynamics of the sustainable finance industry are accelerating as investors and lenders seek to shift their capital allocation to ensure a more ESG-focused portfolio.
While the focus is on ESG responsibility, sustainability is now seen less as a risk management issue and more as an economic imperative. Many institutional investors are mandated to take ESG considerations into account when making investment decisions and having a clear ESG strategy allows companies to respond to investor interest in this area and access funding opportunities. .
What are sustainability loans?
SLLs are loan facilities where the borrower is incentivized through loan pricing to achieve previously agreed sustainability performance goals (SPT). When the SPTs are reached, the borrower is rewarded with a decrease in the applicable interest rate (and conversely, failure to comply with the SPT can result in an increase in the interest premium).
Unlike green bonds and loans, or social loans, SLL proceeds are not required to be earmarked for specific purposes. They offer a higher degree of flexibility and can be used for general business purposes. SLLs also have broader coverage and application across all industry sectors, as SPTs can aim to achieve ESG goals beyond decarbonization and cleaner energies, such as biodiversity, equality and diversity. in the workplace, social and charitable investments and supply chain conditions.
The sustainability-related lending principles published by the Asia Pacific Loan Market Association, Loan Market Association, and Loan Syndications and Trading Association provide a useful framework for agreeing SLLs, including that SPTs should be ambitious and meaningful based on recent levels of borrower performance, and that a carefully designed mechanism to independently verify borrowers’ ESG performance is required. These aspects are essential for the parties to the transaction to ensure the rigor and integrity of SLLs, but also allow borrowers to tailor their SPTs to issues that are important to their business and for which they see an ability to improve performance.
Opportunity for borrowers and treasurers
The recent emphasis on ESG and the goal of net zero emissions offers companies an excellent opportunity to examine their business models and to implement or scale up sustainability strategies with a view to integrating them into financing strategies. SLLs offer a range of large, SMEs and small entities the opportunity to access a financial product linked to sustainability, whether through large syndicated financing or a simpler bilateral agreement.
For borrowers to take full advantage of the growing SLL market, they need a coherent, meaningful and verifiable sustainability strategy. Working with their lenders to structure SLL loans, borrowers will need to communicate their sustainability strategies, policies and goals and assess which SPTs are appropriate and meaningful to underpin the SLL that can push the borrower to improve their ESG performance.
Corporate CEOs, seeking to keep pace with the demands placed on them to achieve ESG goals, can now also look to their treasurers and CFOs to play a leading role in shaping a program. ESG clear, and are more likely to reap the benefits. By focusing on the risks and financing needs of the business, treasurers and CFOs can not only play a key role in the purchase of SLL, but also in the integration and integration of the objectives. ESG in broader business strategies in order to align the financial interests of the business with ESG. Treasurers and CFOs, as well as the CEO, are well positioned within an organization to be leaders and drivers of change in advancing the Sustainable Development Goals. By integrating best practices into governance frameworks and strategic developments, they will be able to establish a solid foundation for conversations about SLL with financiers.
Maintaining meaningful banking relationships will also be essential. Many large banks now have ESG teams to help borrowing clients assess whether SLL may be a funding option. The need to disclose, report and test SPT goals in addition to financial performance also means that SLLs will require a greater level of engagement with financiers. By demonstrating a sound knowledge of the company’s ESG goals and strategy and building strong relationships with financiers focused on supporting SLL products, treasurers and CFOs can put themselves in a position to lead discussions effectively. to pursue SLL.
Challenges and Risks
Once a borrower has entered into an SLL, they will need to be aware of their ability to achieve SPTs. The consequences of non-compliance with a SPT will usually translate into an impact on prices under the loan, which will also need to be considered in relation to its interaction with meeting financial commitments. Corporate treasurers and CFOs are therefore encouraged to play a key role in achieving PTS and to work with the CEO to ensure company-wide operational change to embed sustainability into practices. commercial. In doing so, they must ensure the understanding and commitment of key stakeholders. Identifying the specific changes needed, engaging the right staff and implementing thoughtful messages and incentives will be essential to reshape the company’s ESG approach and advance the company’s sustainability programs. so that it can benefit from a lower interest rate margin.
The higher transaction costs associated with negotiating an appropriate SPT framework and the ongoing monitoring and reporting requirements are a major challenge in pursuing SLLs. Financiers and regulators are responding to these issues with some financiers developing their own in-house frameworks to help borrowing clients with a grassroots position. Regulators are also developing frameworks to reduce costs and barriers to borrowers’ access to these products. For example, the Monetary Authority of Singapore recently launched a Green and Sustainability Lending Program, where certain transaction costs of financiers and borrowers are met for qualifying green and sustainable financing. , thus increasing the accessibility of this financing, in particular for small and medium-sized enterprises.
Another challenge is that standard market practices have not fully developed for SLLs, and there is a need to develop knowledge and understanding of the SLL industry. With an expected increase in SLL, an expansion of the SLL knowledge base will allow for greater ease of transaction.
While there are many aspects to consider to ensure that SLLs can be successfully organized, executed and managed compared to SPTs, they present a real opportunity for borrowers with sustainability strategies to access capital from a lower cost of finance, making it an attractive source of finance for businesses that are willing to commit to making a difference.