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Sustainability-linked loans soar as green bond issues slow

Last week, Apple issued $2.2 billion in green bonds, raising its total so far to $4.7 billion — and further cementing its status as the top corporate green bond issuer in the United States.

But growth in green bonds actually has slowed after a blistering five years, seemingly ceding some ground to newer sustainability-linked loans with looser requirements.

On the one hand, the emergence of these new loan types is diversifying the overall green finance market and expanding access to companies that might not have qualified for green bonds. On the other, the trend concerns some who believe the various green finance options may fall victim to the same greenwashing that has plagued other aspects of sustainable business.

The distinction between bonds and loans helps to illuminate the challenges and opportunities associated with each: Bonds tie funds to specific types of investments, in this case, those with environmentally beneficial outcomes. Loan funds can be used for general purposes. Sustainability-linked loans tie interest rates to sustainability performance targets (SPTs) the borrower must achieve.

Consider the following examples, the first of a green bond and the second of a sustainability-linked loan, for comparison:

  • PepsiCo announced in mid-October that it had priced its first green bond, the $1 billion proceeds from which will fund a series of sustainable development projects related to plastics and packaging, decarbonization of operations and supply chain, and water.
  • In July, Spain’s fourth-largest telecoms operator, MásMóvil, issued a sustainability-linked loan package. The environmental social and governance (ESG) evaluation score issued to MásMóvil that month by S&P Global Ratings served as the initial reference benchmark for determining changes in the interest rate on both the $110 million revolving credit facility and the $165 million capital expenditure line.

Sustainability-linked loans can be attractive for several reasons. Companies that adhere to the SPTs in their loan agreement often can achieve more favorable terms than those available under conventional loans.

For lenders, S&P Global Ratings reports that some empirical data suggest a link between strong performance on ESG factors and improved corporate financial performance and investment returns. Essentially, lenders may be rationally betting on a better-managed company.

The sustainable debt market and greenwashing risk

According to BloombergNEF (BNEF) data, total sustainable debt issuance surpassed $1 trillion in 2019, in what BNEF characterized as "a landmark moment for the market."

BNEF attributes the surging capital flow to growing investor demand for these types of securities. Green bonds, which debuted in 2007, remain the most mature instrument in the sustainable debt market with $788 billion in total issuance to date. Sustainability-linked loans, which only appeared on the market in 2017, have grown massively to $108 billion in total issuance to date.

To be clear, BNEF’s figures don’t reflect Apple’s Nov. 7 announcement of a $2.2 billion green bond offering. Apple's past issues have focused largely on renewable energy investments. This latest one will support global initiatives intended to reduce emissions from its operations and products.

BNEF’s observation of growing investor demand invites further consideration. Euromoney deputy editor Louise Bowman wrote a comprehensive assessment of the green bond market in which she reported that issuers, wary of the cost and complexity of green bonds, are reluctant to sell them. Bowman cautions that non-green issuers may be all too ready to fill the resulting void, raising the specter of greenwashing.

Indeed, accusations of greenwashing arose recently (PDF) in reference to a $150 million green bond financing for Norwegian oil shipping firm Teekay Shuttle Tankers to fund four new energy-efficient tankers.

The project is slated to save more in carbon dioxide emissions than all of the Tesla cars on Norway’s roads, with each new tanker producing 47 percent less annual emissions than other tankers operating in the North Sea. Nevertheless, the bond faced a downsizing to $125 million after investors raised concerns about the fact that Teekay enables fossil fuel extraction and transportation.

"The need for transparency and effective sustainability-related disclosure practices to avoid ‘ESG-washing’ is crucial to growing the sustainability-linked loan market and the practice of linking loan pricing to ESG performance," said Michael Wilkins, head of sustainable finance at S&P Global Ratings.

Assurance mechanisms

Some mechanisms for verification and setting standards already have emerged, including the Green Loan Principles promulgated in March 2018. Building on those principles, the Sustainability Linked Loan Principles (PDF) (SLLPs) were launched this March. The framework features four core components:

  • How a sustainability-linked loan product must fit into the borrower’s broader corporate responsibility strategy;
  • How to set appropriately ambitious SPTs for each transaction;
  • Reporting practices on progress in meeting SPTs; and
  • The value of using a third party to review and verify a borrower’s performance against its SPTs.

Following on that last component, the proliferation of sustainability-linked loans is also boosting ESG ratings firms such as Sustainalytics and Vigeo Eiris, which have a long history of evaluating companies’ ESG performance on various key performance indicators. Indeed, the very first sustainability-linked loan in 2017 led by ING and Philips tied interest rates to Philips’ ESG rating from Sustainalytics.

A September S&P Global Ratings report highlights concerns about "self-reported and unaudited performance data as well as self-policed and self-determined objectives for sustainability labeling," noting that investors could be dissuaded from a market where the borrower can misreport performance. Of course, S&P Global Ratings provides ESG rating services, so it has a clear interest in promoting third-party assurance. Nevertheless, the point remains sound.

On the same theme, S&P Global Ratings further cautions that investors may be put off by a market where "a variety of company-specific targets could make benchmarking difficult."

Interestingly, an October Reuters piece notes that the same problem exists among third-party ESG rating agencies, which — unlike credit rating agencies — are also hard to compare due to a lack of standardization. "Regulation may be required," the piece notes, "to create the certification and compliance that will aid and speed analysis."

Whether assurance mechanisms ultimately are defined by regulators or the market, the sustainability-linked loan market surely will benefit from robust SPT setting, evaluation and disclosure. If structured correctly, the market is likely to continue expanding and to drive improved ESG performance from companies in the process.

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