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Banks are poor gatekeepers of essential sustainability standards

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Lenders have shown that they are incapable of maintaining the integrity of sustainability-linked loans by signing a £1.1bn ‘sustainability-linked’ facility without having agreed key performance indicators.

UK property developer Grosvenor Group has signed a £1.1bn “sustainability linked” loan, but the lenders — led by co-ordinators NatWest Markets, Santander and SMBC — made a remarkable concession by allowing the borrower to slot in key performance indicators at some point over the next 12 months.

The deal drew anger from bankers away from it. This was not a case of a hyper-aggressive borrower bending lenders over a barrel, but rather banks seeing an unregulated spot in the market where they could gain a competitive edge by loosening terms.

This is, by any standard, a cynical abuse of the banking community’s role in ESG finance.

The company has said that it fully intends to come up with ambitious KPIs, but there is nothing in the documents to compel it to do so.

Some claim, weakly, that the company must put KPIs in place in order to gain the KPI incentive. But given that the margin benefit at top credit ratings is tiny — 2.5bp on average — this does not wash. Besides, the same incentive would reward the company for putting in place unambitious KPIs.

As sustainability-linked loans have rocketed in popularity over the past few years, this publication has repeatedly asked lenders how they intend to maintain the integrity of the product when it is the banks themselves setting the rules. Intense competition means that they have a perverse incentive to weaken KPIs in order to secure more business.

Lenders across Europe have insisted that ESG principles are too important to their institutions, too important to the market, or — in the most extreme cases of self-righteousness — too important for the future of the world, for them to allow standards to slip.

This deal undoes those claims. For the lenders on this trade, high standards on sustainability are optional if it helps land a deal.

There are echoes of the eruption in popularity of covenant-lite loans in the leveraged finance market, starting in 2012. There were no regulations setting a floor for the level of covenants, they were just something the market agreed to abide by, much like sustainability KPIs. At the beginning, it felt like a race to the bottom between banks looking to put together the loosest possible package for a borrower, thereby securing the business, while at the same time keeping investors happy enough to buy the loan.

But the covenant-lite race had a natural floor, since investors do not have the same kind of relationship with borrowers that banks do. If a deal pushed too hard at the limits, it wouldn’t pass muster in the market. This is the same pressure that ensures the terms of sustainability-linked bonds remain at a certain standard.

Bank lenders evidently do not have the same squeamishness — several have proven themselves happy to erode sustainability standards to make a buck.

If banks are to maintain integrity when they espouse their ESG ambitions, or claim they are responsible enough to enforce a high standard of sustainability KPIs, they need to hold themselves accountable and make sure a deal like this is never repeated.

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