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How ESG scores can affect the cost of credit

cost of credit

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Although the practice is still relatively rare, a growing number of U.S. companies are exploiting a new type of financial arrangement linked to the promise of strong performance on their ESG measures: better interest rates on business loans.

In early February, the U.S. arm of Japanese tire company Bridgestone disclosed that it had signed a $1.1 billion credit facility with Tokyo-based global bank SMBC with interest rates pegged to the ESG risk scores it earns from ratings organizations Sustainalytics and FTSE Russell. The better its ESG scores, the less interest it will pay on the borrowed money. The opposite is also true: If the company blows one or more of its ESG goals or slips in a rating, that loan will be more expensive.

The arrangement, touted as one of the first of its kind for the U.S. tire industry, is known as a sustainability-linked loan (SLL). This sort of financial instrument first emerged in 2017, and volumes grew 150 percent between 2018 and 2019 — with more than $137 billion in borrowing driven by SLLs during 2019, according to research by law firm Skadden. And although the first half of 2020 slowed along with the economic shock of the COVID-19 pandemic, the borrowing volume through October of last year was still 29 percent higher than for all of 2018.

Companies are exploiting a new type of financial arrangement linked to strong ESG performance: better interest rates on business loans.

To date, a majority of SLL activity has originated in Europe, but the practice is becoming more common in the U.S. Last March, for example, packaging company Crown Holdings closed a $3.25 billion SLL with BNP Paribas — one of the biggest SLL loans at the time. The loan is linked to Crown’s Sustainalytics rating. 

BNP has also inked deals with JetBlue Airways, linked to its ratings by Vigeo Elris; and services firm WSP Global, which is being measured on three metrics: its reduction in GHG emissions, growth in revenue related to services that benefit the environment and an increase in the number of women in management. “We are proud to be challenging the status quo by formally linking sustainability and financing,” noted WSP’s CFO in a statement.   

Partner power

In December, real estate investment trust Invitation Homes also jumped in with a $3.5 billion credit facility in collaboration with BBVA. Its loan will adjust based on the REIT’s score by the Global Real Estate Sustainability Benchmark, or GRESB. “Sustainability is a core competency, now more than ever, and we anticipate that the demand for loans such as these will only grow as consumers and investors demand full transparency around ESG from the companies they do business with,” said BBVA USA President and CEO Javier Rodriguez Soler, when the deal was announced. 

What’s the attraction for a CFO or treasurer? Unlike green or sustainability bonds — which designate money for specific projects related to transitioning to a clean, just economy such as making renewable energy investments — SLLs can be used for general business purposes. 

That difference is helping sustainability teams capture the interest of their internal treasury teams more easily, noted Davida Heller, senior vice president of sustainability and ESG for financial services firm Citi, during a GreenBiz 21 session last week. “They realize by working on their solutions together, they are able to address all of their goals,” Heller said, adding: “It’s an internal partnership.”

Jose Anes, vice president and corporate treasurer of Bridgestone Americas, told me that the tire company’s treasury organization began approaching banks about the role it could play in supporting the global organization’s sustainability vision. The idea of this “green revolver” arrangement took hold, and the finance team huddled with the sustainability team to determine which metrics should matter. “It started with us as a company really driving to show some accountability and how we were improving scores,” he said.

Bridgestone has certain targets in place for both Sustainalytics and FTSE Russell. For example, if Bridgestone’s ESG risk drops to “Negligible” (the lowest possible level and the best rating that Sustainalytics catalogs), it will realize a better credit rate. (As of this writing, Bridgestone is at the risk level one step above.) Its cost of borrowing will be lowest if it meets the goals for both Sustainalytics and FTSE Russell, Anes said. “On the other side, if our scores get worse, we have skin in the game.”

Bridgestone’s sustainability goals include a commitment to become carbon neutral by 2050, alongside a midterm goal to reduce its CO2 emissions by 50 percent by 2030 compared with 2011 levels. It’s also pledging to use “100 percent sustainable materials” by 2050, with an interim goal of 40 percent of its materials coming from renewable or recycled resources.

Anes said the money will be used for general working capital and the facility has a term of two years. The goal is to evaluate performance upon the expiration and renew if it makes sense. He already believes that’s a strong possibility. 

“Certainly, there are the direct benefits that we get linking to our impact and scores,” Anes noted. “The most important part of this is that it brings heightened visibility and accountability.”

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