Standards under pressure as sustainability-linked borrowing explodes

IFR 2379 - 17 Apr 2021 - 23 Apr 2021
4 min read
Tessa Walsh

Bankers are worried that standards are slipping as more borrowers and banks pile in to the rapidly expanding sustainability-linked bond and loan markets that rely on self-labelling by companies keen to showcase their ESG credentials.

More high-emitting companies are looking for sustainability-linked deals as the transition to a low-carbon economy picks up pace, which is highlighting the need for tighter standards in a critical decade for emissions reduction.

Calls are growing to standardise key performance indicators across instruments and sectors as companies such as French oil major Total get ready to tap the sustainability-linked bond market.

“We strongly believe that the normalisation or standardisation of those KPIs is going to be absolutely critical if we want to protect the market from generalised greenwashing,” said Constance Chalchat, head of company engagement at BNP Paribas.

Many banks lack the expertise and internal mechanisms that allow them to challenge borrowers and end up agreeing deals that have unambitious and undemanding targets.

“Some banks are setting KPIs with the relationship manager sitting in front of borrowers saying ‘how about that?' The problem with not pushing green boundaries to win business is that you go brown,” a senior loan banker said.

Concerns have been raised for years that the private syndicated loan market has been too lax in setting standards, which has let some relationship companies get away with egregious self-labelling.

“Skipping the numbers and focusing on narratives is what I see happening, and it is concerning," said Gianfranco Gianfrate, professor of finance at EDHEC Business School in France.

The need to maintain credibility requires a strong input from banks to push back on borrowers’ demands and to ensure that KPIs are material, additional and ambitious and do more than repackage existing facilities.

"The role of sustainability coordinators in sustainability-linked loans and revolving credits is absolutely critical in that sense as they advise the client on the choice of KPIs and the level of KPIs," Chalchat said.

Level playing field

The move of the sustainability-linked format into the public bond markets has improved transparency as companies had to reveal their KPI targets to investors, along with the sustainability performance targets used to calibrate them.

The world’s three loan trade associations are poised to reveal an update that will bring their 2019 sustainability-linked loan principles in line with ICMA’s recent SLB principles, and confirm the use of KPIs and SPTs.

Having an equal requirement between the loan and bond markets is being seen as progress as it will raise standards in the loan market, allow for better comparison of KPIs and make it easier to refinance between instruments.

SLLs currently have a greater variety of KPIs including social targets with as many as five KPIs per deal, whereas SLBs have one or two KPIs that are typically focused on environmental targets, which can be common to both instruments.

“There is a convergence of KPIs on bonds and loans,” Chalchat said.

Having similar standards and common environmental KPIs could improve standards for all companies. Sustainability specialists are pushing for the disclosure of direct scope 1 and 2 emissions and an estimation of indirect scope 3 emissions from somewhere within a company's supply chain.

“I would quickly introduce mandatory disclosure of scope 1 and scope 2 emissions for each public company and I would ask that to be audited," Gianfrate said.

Scope 3 is difficult to measure, and has not been seen in any loan KPIs to date, bankers said, but is expected to become increasingly important as companies look down their supply chains.

Getting labelling right will be increasingly important, not least for the banking sector, which is facing increased disclosure requirements and greater scrutiny of balance sheets.

"All industries with high scope 3 contributions need to show all three scopes in their assessment or there's no point in doing it," said Hans Beyer, chief sustainability officer at Swedish bank SEB. "Everyone that doesn't care about labelling has a seven to eight-year view that banks will not be required to disclose. They are wrong – disclosure is happening."