Loans linked to ESG face overhaul by under-pressure banks
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[November 10, 2023] By
Tommy Wilkes and Isla Binnie
LONDON/NEW YORK (Reuters) - Corporate loans whose costs are linked to
environmental, social and governance (ESG) goals are being redesigned by
banks in response to rising regulatory pressure and to inject more
credibility into a market they hope to grow.
Sustainability-linked loans (SLL), which were first used in 2017, offer
slightly cheaper borrowing, typically around 2.5-10 basis points less,
if companies meet goals such as cutting their carbon emissions or
improving board diversity.
Banks need to balance tougher standards without killing demand for SLLs,
which unlike loans tied to specific projects allow borrowers to use the
money raised however they choose, as they count towards lenders' own
sustainable finance commitments.
"There is no more hype," said Constance Chalchat, chief sustainability
officer for BNP Paribas Corporate and Institutional Banking. "If you are
not 100% bulletproof, it can create greenwashing or reputational risks."
Of 14 major banks reviewed by Reuters, JPMorgan was the only one which
did not automatically count labeled loans and bonds towards its own
sustainable finance target.
Amid increasing regulatory scrutiny and suggestions that SLLs enable
companies to inflate their green credentials, LSEG data shows issuance
has slumped by 36% to $310 billion so far in 2023, from $480 billion in
2022. Total loan volumes also fell in the period, but by a less sharp
21%.
This drop is despite big SLL deals this year from repeat borrowers such
as German utility RWE, automaker Ford Motors and French energy group
Engie.
In a sign of how the market is changing, an Engie spokesman said the
most recent documentation it had signed for SLLs, of which LSEG data
shows it has agreed $4.8 billion, included "declassification" clauses.
These let banks strip the sustainability-linked label from the loans if
targets are no longer deemed appropriate.
The banks' tougher standards are discouraging some borrowers from using
SLLs entirely, bankers and lawyers told Reuters.
Others are first "looking at structures more closely", said Credit
Agricole CIB's Head of European Corporate - Sustainable Investment
Banking, Pascale Forde Maurice.
Britain's Financial Conduct Authority (FCA) warned in June of "market
integrity" concerns, including weak incentives, potential conflicts of
interest and unambitious goals.
The FCA said banks' remuneration incentives to hit ESG financing targets
may have created potential conflicts of interest, encouraging them to
accept weak corporate targets.
'SEVERE CONTROVERSY'
Banks have responded by including more penalties in SLLs that raise the
borrowing cost if a company misses targets.
They are also insisting on the right to remove the SLL label for a
"severe controversy", and are using untested language such as the
company or its products having an "adverse impact" on the environment,
the borrower's social principles or governance, said Elliot Beard, a
partner at Simmons & Simmons.
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Signage is seen for the FCA (Financial Conduct Authority), the UK's
financial regulatory body, at their head offices in London, Britain
March 10, 2022. REUTERS/Toby Melville/File Photo
They are broadening definitions of a "sustainability amendment
event" too, which was traditionally invoked if an acquisition or
disposal altered a firm's sustainability profile.
Beard said this is being stretched to include regulatory change,
business strategy shifts and "any other event" which banks believe
materially impacts sustainability goals.
"That would give lenders significant latitude to say let's get round
the table and renegotiate ... I've not seen that accepted but that's
what some banks are pushing for," he added.
Lenders and lawyers are also considering clauses to trigger a
default, which requires immediate repayment, if a borrower is deemed
to have reneged on sustainability commitments.
Already appearing in some private deals, such a clause "provides
more teeth" but could scare away more borrowers, said David
Milligan, partner at Norton Rose Fulbright.
The Engie spokesman said the utility would not agree to linking an
event of default to sustainability targets.
PUBLIC SCRUTINY?
The London-based Loan Market Association, which tightened guidelines
for lenders structuring SLLs alongside industry bodies in North
America and Asia, says standards are improving. Its head of
sustainability Gemma Lawrence-Pardew said banks and borrowers need
to go further still, by publishing the sustainability elements of
loans for public scrutiny.
Private lenders are also aiming to be more rigorous.
"We have stated our willingness to walk away when sustainability
targets were too soft," said Brittany Agostino, vice president in
the environmental, social and governance group at Los Angeles-based
Ares.
"We request historical data on energy efficiency targets, and we
built in safeguards to prevent companies from using M&A (mergers and
acquisitions) just to meet these."
However, some doubt the value of sustainability-linked debt.
BMW completed an 8 billion euro ($8.5 billion) revolving credit
facility in June, but unlike fellow automaker Porsche, decided
against an SLL.
Corporate finance director Fredrik Altmann told Reuters that such
debt serves BMW and its investors poorly.
"Our investors need to understand what drives BMW," he said. "That
won't happen if one KPI (key performance indicator) or two KPIs
decide if a labelled transaction is green or not."
(Reporting by Tommy Reggiori Wilkes and Isla Binnie; Additional
reporting by Shankar Ramakrishnan in New York; Editing by Simon
Jessop and Alexander Smith)
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