Sustainability-linked loans, a form of debt issuance linked to hitting certain sustainability targets, are haemorrhaging clients – in line with falling green investment across the board.
Sustainability-linked loans are a relatively new – and increasingly controversial – form of loan for which interest rates are linked to hitting sustainability targets. The idea is to give businesses an incentive to get greener while improving the ESG credentials of issuers and issuees. It should be a win-win. The problem is that a lack of regulation has meant the targets have often not gone much further than words like green or sustainable.
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GlobalCapital’s Jon Hay argued in February that such loans have too many performance indicators and too little disclosure to be effective or trusted. Earlier this week, Bloomberg’s data bore that out, showing that sustainability-linked loan issuance fell 56% in 2023 and has fallen by 74% so far this year.
This fall from grace was not inevitable. After their 2017 debut, the loans’ popularity skyrocketed, creating about $688bn of finance between then and 2021 – 85% of all sustainability-linked financing, according to an IFC report. The same report, published in January 2022, holds some insights into the problems that were to come.
While green metrics remained the predominant way to assess interest rates, metrics including female staff and worker safety were experiencing monumental growth – 1,364% in the case of the former. While undeniably important, their link to sustainability is less than apparent.
The failure to self-regulate led to a watershed in 2023 when the UK’s Financial Conduct Authority published a letter raising concerns with the sustainability-linked loan market ranging from a lack of trust to potential conflicts of interest. The independent regulatory body said: “We also noted a general sentiment among banks that the ‘relationship’ may matter more than the borrower’s sustainability credentials – the former may therefore disproportionately drive the bank’s decision to participate in the loan.”
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By GlobalDataCan sustainability-linked loans recover?
Regulation is not yet forthcoming, placing sustainability-linked loans in a tough spot: unregulated enough not to be trusted but with the looming threat that future measures could render previous loans invalid.
Jeff Walker, head of sustainable finance at consultancy ENGIE Impact tells Energy Monitor: “The falloff in SLLs [sustainability-linked loans] can be explained by the confluence of two factors. The market is becoming more incredulous of the sustainability KPIs that companies attach to their SLLs, and demanding more credible, meaningful measures. In that environment, it’s no wonder that companies are feeling trigger-shy and are reluctant to step out with a SLL that could be perceived as lacking ambition.
“In parallel, there are regulatory changes afoot, particularly in Europe, that seek to define what is considered sustainable. Issuers would be wise to wait for more clarity on these regulations to ensure that any SLLs they issue track the common understanding of what qualifies as sustainable. Both of these factors are evidence of a market in flux, so we shouldn’t be surprised to see a resurgence of SLLs when there’s a realignment of market expectations, regulatory clarity and issuer objectives.”
This, alongside a broad trend of slowing green investment in recent years, has driven corporations and banks away from the product. It may not be the end for sustainability-linked loans, however.
Last month, behavioural economist David Lewis told Energy Monitor’s sister publication Private Banker International that while the general decline in ESG investing may be disheartening, the funds that remain may be stronger, greener and more enticing to investors, building the sector back in a truly sustainable fashion.
Other industry experts are also hopeful. Branson Knowles, head of US digital banking at Top Mobile Banks, tells Energy Monitor: “Some banks may be ‘ESG-washing’, but many have actually committed to meaningful work. Accountability and openness provide a difficulty. This could be addressed by independent auditing of loan terms and sustainability targets. Industry standards would be beneficial as well, but we don’t want to impede innovation.
“Ultimately, SLLs require commitment from both lenders and borrowers. Banks must incentivise ambition, not laxity. Borrowers should set targets aligned with science-based pathways. Progress requires collaboration, not finger-pointing. With care and vigilance, these tools can still drive progress.”
Co-founder of Emitwize Mauro Cozzi explains that the difficulties sustainability-linked loans face are tough, but not insurmountable, stressing the role of the CSRD: “We are not surprised by the recent news regarding SLLs haemorrhaging clients due to greenwashing fears. SLLs require robust underlying data to demonstrate compliance. In the past, lax scrutiny allowed companies to present questionable data on carbon reduction efforts.
“But now, with the Corporate Sustainability Reporting Directive (CSRD) demanding auditable data, companies are having to reassess their readiness for SLLs. To combat greenwashing and restore confidence in SLLs, companies must prioritise obtaining accurate and auditable data.”
