Growth in sustainable loans has accelerated dramatically in recent years. BNP Paribas' sustainable finance specialists and the Loan Market Association discuss the main trends shaping the market globally.
Environmental Finance: What key developments are driving the sustainable loan market?
Constance Chalchat: We have seen significant growth in the sustainable loan market in EMEA in recent years. A quarter of the EMEA loan market volume is currently accounted for by sustainability-linked loans (SLLs). This growth has been met by growing scrutiny from regulators keen to tackle greenwashing.
Nevertheless, approximately 50% of revolving credit facilities (RCFs) in EMEA are renewed as SLLs. This demonstrates continued interest from borrowers to embed ESG features as part of their financing needs.
The first wave of growth in SLLs came from companies that had already established their sustainability plan and related performance metrics. However, during this period of exponential growth, we also saw companies with the intention to link their financing with ESG features but that were not mature enough in their sustainability plans to be able to implement them to the highest standard.
With this rapid growth, we have seen increasing scrutiny from market participants. To tackle greenwashing, regulators are now looking at the segment more closely. As a result, growth has normalised.
Greenwashing is still an issue in the 'silent' or 'sleeping' SLL segment when not adequately structured. In particular, no public communication should be launched until the SLL features have been activated and, where feasible, all lenders should approve the SLL features.
In order to promote integrity and credibility in the sustainable lending market, the Loan Markets Association (LMA) reflected best market practice in various documents published over the years. In 2023, the updated LMA Principles are very thorough and reflect recent market development across the global sustainable finance market, and we encourage all banks structuring SLLs to closely follow these. With widespread adoption of these principles, we will see a significant reduction in greenwashing issues.
Sustainable loans allow a company to display their ambition and commitment to sustainability to banks. Lenders know that if a client is not serious about their sustainable transition, they're going to be subject to transition risks or climate risks. Essentially, it puts a value on sustainability risk management.
Given the bank's active role as a sustainability coordinator for companies across a range of sectors, we rely on having a deep understanding of a company's sustainability journey and also integrating ESG data in a material way into the transaction process.
EF: How is the LMA's guidance developing to support the robustness of a market based on integrity, good data, and avoiding greenwashing risk?
Gemma Lawrence-Pardew: The LMA Green, Social and Sustainability-Linked Loan Principles - produced jointly with the Asia Pacific Loan Market Association and Loan Syndications and Trading Association (LSTA) – provide recommended frameworks of market standards and guidelines for use across sustainable loan products. At their heart, the Principles look to create a strong foundation based around concepts of ambition, integrity and transparency by setting baseline requirements around project/target setting, reporting and verification. Accurate reporting, supported by robust verification, should enhance the reliability of data. In addition, adherence to not only the wording of the Principles but also the spirit, should see greenwashing risks minimised.
The dynamic nature of sustainability-related regulation, covering a myriad of issues, from disclosure to greenwashing to supply chain considerations, requires increasing expertise amongst market participants so we shall likely see a significant upskilling of transaction teams on ESG-related issues moving forward.
Following on from this, on the SLL front, at the LMA we are continually encouraging members to ensure KPIs are selected to withstand the increasing scrutiny of press, the broader market and ensure alignment towards credible transition pathways.
EF: How are you seeing this evolution of KPIs, Agnes?
Agnes Gourc: We've had a broad diversity of KPIs in the loan market for a long time. However, a big challenge has been finding a way to address Scope 3 emissions (or in other words, the emissions related to the corporate value chain) in the SLL structure.
When we look at H1 2023, the trend for the inclusion of Scope 3 targets in transactions is encouraging. The Scope 3 discussion is a far-reaching one as it will involve a company's supply chain and use of product sold. It's about finding what is achievable today for a given company, even if that means it is a partial target. Some transactions have embedded a one-time test of a Scope 3 target, rather than an annual test. This longer leeway for Scope 3 is sometimes what is needed to take into consideration the paramount changes companies will have to implement in order to influence their Scope 3 emissions.
We have also seen an evolution in social KPIs. Typically, we have seen KPIs largely focused on gender diversity. Now we are seeing more focused on local communities, retraining the workforce, and other social elements that go beyond the crosscutting issue of gender diversity. Furthermore, we are seeing less utilisation of ESG ratings as companies are more advanced at setting internal KPIs. That is useful as it is a more direct read of what they are doing.
We are also seeing more scrutiny and expertise generally in the SLL market when it comes to the materiality of KPIs and ambition of targets. This is also a good development. It means we can engage in meaningful discussions on why a company has chosen a particular KPI and we can address the ambitiousness of a target for better outcomes.
The banking relationship with a loan is a continuous one and allows a yearly review of a company's sustainability strategy. An SLL is a useful instrument in making sure the company's sustainability performance keeps progressing; if it does not evolve in the right direction, it allows us to actively engage as to the underlying reasons and explore possible solutions.
Finally, the ICMA KPI registry has proven to be very useful across sustainability-linked transactions. Whatever market we are operating in, this is a key point of reference for us, and more and more market participants are using it when it comes to loans as well.
EF: What key sector developments in the APAC region are you seeing, Chaoni?
Chaoni Huang: There is increasing momentum in decarbonisation within the hard-to-abate sectors in APAC, such as steel and cement producers, etc. We discuss with clients their transition trajectory and consider how we can help ambitious companies in these sectors accelerate their transition through sustainable finance.
On an instrument level, SLLs are an effective instrument in addressing the key financing challenges that they face as they embark on their ESG journeys. However, both use of proceeds and sustainability-linked structures are viable options for hard-to-abate sectors. There are clear capital expenditure (capex) and operational (opex) needs for these particular sectors and these two products intertwine perfectly to deliver that.
EF: How is the alignment to definitions and standards evolving between APAC and EMEA?
Chaoni Huang: In a sea of emerging taxonomies, many discussions seem to be more focused on the differences between them. In fact, there's a high degree of overlap between the taxonomies across different jurisdictions. Take the example of China and the EU – the two biggest markets when it comes to green finance – the efforts by the International Platform on Sustainable Finance have demonstrated that there's a good degree of overlap and the Common Ground Taxonomy is an example of how we can look at both differences and commonalities to ensure capital flow across borders.
While local context and priorities should be taken into consideration in the taxonomy development a high enough degree of overlap will help facilitate the growth of the sustainable financing market.
For both the bond and the loan market, we try to be consistent in applying the relevant principles and standards even though they are different kinds of instruments. Regardless of the instrument, we want to maintain the high standards and make sure we have conviction when it comes to the ESG features of our lending facilities across the region. There's a perception that sustainability financing in Asia might not be up to international standards. That's certainly not the case. In fact, we tend to apply even more stringent standards to change that perception.
EF: In terms of regional momentum, global industry standards bodies are engaging on creating common definitions of sustainable finance in the loan market. Where are you seeing momentum in the Americas, Anne?
Anne van Riel: In the US in particular, we are seeing growing demand for green loans on the back of the US Inflation Reduction Act. There are a lot of investments directed towards battery manufacturing, green hydrogen, and infrastructure for renewable energy. Adherence to the Green Loan Principles is increasing for project finance loans as well.
In terms of SLLs, we have seen a significant slowdown of companies including KPIs in their facilities. Everybody is in a wait-and-see mode in terms of uncertainty around the Securities and Exchange Commission (SEC) proposals. Companies don't want to commit to something and then have a major piece of legislation dictating what they need to report on, because otherwise, they may find themselves double reporting a credit agreement for the SEC, for example.
For clients that are choosing SLLs, we have had good feedback regarding co-benefits for their organisations. Clients often comment that internal communication and goal setting have improved operations as awareness has improved for what they need to achieve. In addition, there is more transparency, and sustainability professionals are helped by the guidance that the market provides.
Our work has evolved over the last few years in line with the market, as we follow the LMA, LSTA and the ICMA guidelines for materiality, relevance, and ambition. Those are very important drivers in the conversations we have with clients.
Most market participants are cognisant of greenwashing risk and are actively mitigating this. Our clients take it as seriously as we do, and everyone is trying to move the market forward in a robust and material way.
In Latam, there is very strong momentum on both the sustainable loan and the bond side. There is a lot more focus on social use of proceeds for both, while US corporates tend to incorporate social targets alongside a GHG target.
EF: Social loans are becoming an increasingly valuable tool in the Americas for sustainable development. For example, in Latin America cities represent a huge potential for advancing sustainability and just transition using the green/sustainable loan instrument. How does the LMA see further integration of social factors into the loan market and how this can support a just transition?
Hannah Vanstone: Covid-19 and the climate crisis have emphasised the importance of ensuring finance for social issues at a global level. Social metrics are increasingly being considered in loan market transactions, although their prevalence is often dictated by the borrower's jurisdiction and the underlying political and regulatory environment. What is vital for further integration is the creation of social taxonomies or roadmaps as seen in the 'green' space.
As we look to transition towards a net-zero economy, the social impacts of transition must be carefully considered and addressed – an issue which is increasingly recognised by regulators and global alliances.
Social factors, particularly in developing economies, will rise in importance as finance will be required to help re-orient companies and employees in a just and equitable manner. The rise of social factors will be further supported by increasing regulatory efforts to anchor human rights throughout value chains.
EF: What is on the horizon for sustainable loans?
Gemma Lawrence-Pardew: Transition finance, and the importance of a just transition, will continue to remain a key topic for years to come. In addition, we expect to see a greater focus on environmental issues outside of greenhouse gas emissions, most notably biodiversity and nature. Sustainable finance must not simply be defined by financing the removal of negatives but promoting the creation of positives. We hope a wider focus will be matched with a change in language – to promote best practices as well as reduce harmful ones.
Constance Chalchat is head of CIB company engagement and global markets chief sustainability officer at BNP Paribas; Agnes Gourc is head of sustainable capital markets at BNP Paribas; Chaoni Huang, head of sustainable capital markets at BNP Paribas APAC; Anne van Riel is head of sustainable finance capital markets at BNP Paribas Americas.
Gemma Lawrence-Pardew is sustainability head, and Hannah Vanstone is senior associate director at the LMA.
For more information, see: cib.bnpparibas/low-carbon/ and https://www.lma.eu.com/