How sustainability-linked loans went wrong
The product was used lazily, and without understanding its potential
The excitement when Philips and Unibail issued the first publicised sustainability-linked loans in 2017 was palpable. The loan market had at last found a way in to the green debt craze.
In the process, it created a genuine structural innovation that would soon be copied by the bond market: variable pricing that rewarded the borrower for hitting sustainability targets, or penalised it for missing them. Another breakthrough: it worked for companies without large volumes of green spending.
The product’s growth in the next four years was meteoric. Every company, it seemed, had to have a sustainability-linked loan. Many applied the technique to their ordinary, undrawn corporate revolving facilities.
Then the market lost its way. Criticisms began to mount that some structures were shoddy, companies set unambitious targets and the interest rate ratchets were minuscule.
The spectre of greenwashing loomed. Could banks or borrowers get in trouble for calling these weak instruments sustainable?
Last year, issuance tumbled. As GlobalCapital reports this week, it is hard to find a loans banker willing to defend SLLs, let alone enthuse about them.
An innovative deal this week by Acciona, the Spanish infrastructure group, shows SLLs still have dedicated followers. But their appeal could dim further if banks decide they don’t need them.
A grown-up understanding of environmental, social and governance investing has at last arrived in banking, 20 years after it did in the equity market. Every investment decision should take into account the borrower’s ESG characteristics.
If they are doing that on all loans, bankers are wondering, why do they need special ESG structures?
A fair point, but it shows how far the potential of SLLs has been wasted and misunderstood. Linking your funding cost to sustainability targets is a brave way to underline your commitment to them. As sustainability-linked bond issuers have understood, it sends a strong message to the market.
But nearly all SLL borrowers have thrown away that advantage by keeping the details of their SLLs private. The targets they are linked to are often revealed only vaguely, with no figures.
This is partly, specialists say, because companies use annual targets for SLLs, but may not want to disclose them to the market, when their official corporate sustainability targets are only for 2025 or 2030. But annual targets are a deliberate choice; the loans don’t have to be done that way.
Companies and banks have loaded SLLs with far too many key performance indicators — five is common. And since the structures are private, one wonders what the point is — who the company is actually communicating with?
Instead of treating the structures as intrinsically valuable and making them rigorous, banks have used them as an easy way to pile up sustainable finance credits with the regulator.
Properly structured SLLs with public criteria remain a valid instrument for signalling a company’s sustainability commitment. That is not diminished at all by banks learning to evaluate all companies’ ESG features. For strong and weak ESG performers, the SLL remains a way to show, and reward, progress in transition.
The loan market should save SLLs from the damage done by their enthusiasts — if it is not already too late.