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 integrate into the financing. Today, all publicly listed corporations have a corporate social responsibility (CSR) strategy, but this strategy is typically based on medium- to long-term objectives. The strategy should be broken down into quantifiable annual objectives so the lenders can assess the company’s progress on ESG issues.
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 is complete, it is possible to amend existing financing contracts to include CSR indicators. It is also possible to integrate these indicators into an inaugural syndicated loan or refinancing. The indicators should be relevant to the group’s activity, and they must show ambitious potential for improvement so that the lenders recognize the commitment of the company.
– 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 most lenders recognize. However, the current trend is to adopt extra-financial criteria, which are material, impactful and specific to the company in line with its CSR approach. With these indicators, it becomes easier to convince lenders.
– Do banks have a harmonized vision of the indicators presented by companies for environmental concerns? Do their requirements converge?
– Banks do not share a consistent view of necessary action 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. In the meatine, companies can receive credit for their carbon footprint plans.
– What about social indicators?
– Similar to the environmental sector, the focus and demands of banks regarding 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.
Banks have a tendency to want to homogenize their analyses across sectors. The closeness of the banking relationship plays a major role in banks’ willingness to customize the approach. 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 have more ambitious objectives to avoid the greenwashing of credit funds, the gain is approximately 20 bps, and can reach 25bps. Importantly, equity investors are also increasing their focus on this topic, so a sustainable financing can also signal the company’s commitment to sustainability to the market.