Sustainability-linked loan volume is falling amid a broader loan market slowdown as tightening standards from industry bodies make borrowers more cautious about disclosure and the potential threat of litigation.
SLL volume fell faster than overall global loan volume in the first quarter after a heavy drop in the fourth quarter of 2022, according to Refinitiv LPC data. That trend is expected to continue as borrowers adjust to tighter SLL principles.
The three global loan trade associations on February 23 updated the voluntary principles governing sustainability-linked lending. The move, which many in the market consider overdue, increased the requirements for ambition and materiality in setting targets and external verification.
While some borrowers are concerned about increased costs and more demanding commitments, more are worried that publishing their targets and performance could attract the attention of NGOs, which might result in bad publicity or even litigation.
“We have been hearing about lower SLL volume in the market. External verification is still costly, but what we are hearing is driving down volume more is increasing concern about climate-risk litigation,” said Gemma Lawrence-Pardew, head of sustainability and director of legal at the Loan Market Association, the London-based trade body that oversees the market in Europe.
But fewer SLLs of better quality is not necessarily a bad thing, Lawrence-Pardew said. “It would depend on why volumes are reducing. If it is purely a quality point then I think that is a positive story as people look to maximise the integrity of the market,” she said. “If it is fuelled by fear of litigation risk, irrespective of quality, then this would be something that needs addressing.”
Some in the loan market are even concerned that such is the nervousness among borrowers about the politicisation of ESG issues – especially in the US – that some companies might be “greenhushing” or choosing to under-report or hide their ESG credentials from public view by issuing conventional loans rather than SLLs.
SLL volume was US$102bn in the fourth quarter of 2022, a 28% decrease from US$143.5bn in the third quarter. Overall loan volume totalled US$986bn in the fourth quarter, roughly flat with the previous quarter, according to LPC data.
SLLs continued to see a steep decline in the first quarter with a 27% drop to US$74bn, while global loan volume contracted by 24% to US$745.8bn.
SLLs made up 9.9% of overall global loan market volume in the first quarter, down from a high of 15% in the second quarter of 2022 and 10.4% in the fourth quarter.
This downward trend is likely to continue, with US$85bn of SLLs completed in the second quarter so far, which is 58% lower than the US$203.45bn completed at the same point of the second quarter in 2022.
A downturn in SLL volume has wider significance for the banking industry as SLLs are a key product for banks seeking to implement their own targets on the provision of sustainable finance and commitments to reduce the carbon intensity of loan books and measure how they are contributing to energy transition.
The SLL update has nonetheless been applauded by arranging banks, such as ING, which is credited with inventing the structure with the first SLL, a €1bn deal for Dutch company Philips in 2017.
"I think we're going to be under higher scrutiny as banks, so getting SLL structuring right is becoming more and more important," said Jacomijn Vels, global head of sustainable finance at ING. "We view the LMA's focus on the materiality, the ambition and the relevance of the KPIs, together with recommending an annual check on the KPIs, as an important and positive recommendation."
The February update, which seeks to align guidance governing SLLs with that from the International Capital Market Association governing sustainability-linked bonds, gave firmer direction on disclosure and transparent reporting and public accountability as a protection against greenwashing. It is intended to refocus attention on the ESG characteristics of transactions and help borrowers and arranging banks set more effective KPIs.
"I think borrowers are becoming more aware of the risks of not having stretching KPIs and potential litigation, and the market is aware that regulators have been looking at sustainability-linked products in the bond and loan markets in the last six months in the UK and Europe," Lawrence-Pardew said.
Regulatory interest from the UK's Financial Conduct Authority and its European counterparts is a powerful motivator to address outstanding issues, which include the verification and assurance of KPIs and other targets, including Scope 3 greenhouse gas emissions from companies' supply and value chains.
The update nonetheless gives banks a lot of wiggle room. "The challenge is that the guidance is high level and thus every bank decides for themselves, which doesn’t necessarily create a level playing field," Vels said.
Her colleague Arash Mojabi, UK lead of sustainable finance at ING, expressed similar concerns. "The LMA guidance is interesting. [But as] it's only three pages there are some natural ambiguities and differing interpretations," he said.