Continuing our series of articles dedicated to sustainable finance, Muriel Nahmias, Senior Director - Debt Advisory at Redbridge, talks about some important things to consider in the implementation of a Sustainable Linked Loan.

- How does the implementation of a Sustainable Linked Loan (SLL) begin?

- The implementation of an SLL starts with a reflection on the environmental, social and governance (ESG) indicators to be integrated into the financing. Today, all listed groups have a corporate social responsibility (CSR) strategy, but this strategy is normally expressed in terms of medium- to long-term objectives. The strategy should be broken down into quantifiable annual objectives so the company's progress on ESG issues can be assessed by the lenders.

Defining the ESG objectives involves between one and two months of work. It is a cross-functional project, involving many departments in the company. The finance department generally works directly with the general management team. The challenge is to commit the entire group to sustainable financing.

Once this work has been carried out, it is possible to amend existing financing contracts to include CSR indicators. It is possible as well to integrate these indicators into an inaugural syndicated loan or refinancing. The indicators should be relevant to the group’s activity, and they must also show ambitious potential for improvement so that the lenders recognize the work the company is committing to.

- In order to implement sustainable financing, is it essential for a company to have an ESG rating or a label / certification?

- It is not essential, but it can be useful in certain cases. An external ESG rating, even unsolicited, is an indicator of a company’s sustainability profile that is recognized by most lenders. However, the current trend is to adopt extra-financial criteria specific to the company: in line with the CSR approach, material, impactful. With these indicators, it becomes easier to convince lenders.

- Do banks have a harmonized vision of the indicators presented by companies? Do their requirements converge?

- Banks share a consistent view of what needs to be done to address global warming. Some lenders consider the communication of a carbon footprint to be sufficient, while others require firms to make quantified commitments to reduce their direct emissions (Scope 1) and indirect emissions linked the consumption of electricity, cooling and heating (Scope 2). Companies rarely provide details of their upstream and downstream emissions (Scope 3).

The majority of SMEs will not be able to present a Scope 1 assessment before 2022–23. Alternatively, it is still possible to present a strategy to quantify the carbon footprint.

- What about social indicators?

- The focus and demands of banks in relation to social criteria are quite variable. The difficulty in negotiating sustainable financing is to get the lenders to agree on a set of criteria and on a trajectory of ESG improvements and reach a consensus that is favorable to the borrower.

This negotiation is indicative of each bank's understanding of the company's business model and products. The closeness of the relationship plays a major role.

Banks have a tendency to want to homogenize their analyses across sectors. Fortunately, some lenders work to understand the business model and the relevant indicators. The human factor counts for a lot in the implementation of an SLL!

- What is the difference between SLLs and Sustainable Linked Bonds (SLBs)?

- SLBs follow the principles set by the International Capital Markets Association (ICMA). These principles are more stringent and not very ESG rating-friendly. The requirements of SLBs reflect the reporting obligations of institutional investors. It is necessary to produce indicators that are relevant, essential, material, measurable, verifiable by an external entity and comparable to an external reference or definitions (for example, compliance with the Paris Agreement on global warming). The indicators must also refer to regulatory standards or objectives set by international organizations (such as the green bonds principles).

- In the end, does it pay to switch to sustainable finance?

- The objective of sustainable financing is to link the company’s financial conditions to the achievement of certain ESG objectives. For bank financing, the improvement in margin is currently symbolic, at around 5 bps. For bonds, which follow more ambitious objectives to avoid the greenwashing of credit funds, the gain is in the order of 20 bps, and can reach 25bps.