Green revolvers – a game-changing innovation for ESG
Green financing has taken root in the syndicated loan market, with structures that reward a borrower with cheaper margins if it manages to hit sustainability targets. These should be applauded: they could have a far greater environmental impact than the use of proceeds technique used for green bonds.
The boom in green financing has taken longer to enter the loan market than bonds, but the loan market is catching up fast, and doing things its own way.
While some loans are equivalent to bonds, in being essentially term funding that can be raised for a specific purpose, many Western investment grade companies do not use loans in this way. Instead, they have corporate revolving credit facilities that they can draw on for any need that arises — or leave undrawn. Such facilities do not really suit the template of green bonds, which is based on allocating the proceeds raised to a specific set of green investments, and reporting to investors on how the money is used.
But product innovation is one of the crowning glories of the banking sector (or evils, depending on whom you ask). Even the slowly moving and staunchly traditional loan market is capable of inventing something new from time to time, and in this instance the workaround is better than the original product.
To turn a revolving credit facility into a green financing, the loan market has come up with a structure that gives borrowers a set of environmental, sustainable or governance (ESG) targets to hit. The precise metrics are chosen by the borrower, usually in line with targets it is already working towards.
They might include reducing greenhouse gas emissions, as Royal DSM, the Dutch ingredients and specialist materials group, agreed to do when it signed a €1bn green revolver at the end of May, or transitioning to low emission vehicles and cutting serious workplace accidents, as waste management company Renewi signed up to in its €550m green loan.
Unlike a green bond (and other green loans, which ape the green bond template), in these deals the ESG-friendly performance must be achieved across the whole company, not just in part of its business.
Borrowers set themselves up for embarrassment if they fail to hit the targets, which is a powerful incentive to do so. And if acute humiliation is not enough of a whip, there is another reward that even the most unwaveringly capitalist, climate change-sceptical of chief financial officers can get behind — money. In return for hitting the ESG milestones, lenders will lower the margin on the revolver.
As the focus of this structure is on improvement, rather than a static set of investments, this green revolving credit facility structure could be applied to companies well outside the usual hunting ground for green bonds without too much uproar. Oil and gas companies could be rewarded with cheaper bank funding for becoming greener — a win for everyone — rather than for explicitly undertaking green projects, as would be required for green bond funding.
The structure for green revolving loans sets a new standard for ESG financing. This higher bar could inspire positive changes across entire companies, rather than giving firms the easier option of concentrating their greening activity in a certain part of the business. And for lenders, it puts the focus where it should be: on the whole organisation’s attitude to ESG, which is ultimately what will determine the risk lenders face.