World Bank Review: Sustainable Lending – Are We Still There?

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This article is part of our World Bank Review 2021 – ESG: Creating a future that makes sense, an annual publication from our Global Banks industry group that brings together our people who live and breathe banking.

Sustainability-linked loans, which have additional pricing advantages for borrowers who meet set sustainability goals, have grown in popularity significantly over the past 18 months, reflecting greater growth in ESG financing. However, we have not yet reached the point where they are common options for all borrowers.

For example, the popularity of sustainability loans varies considerably from region to region. They are now common in Europe, with 65% of companies surveyed in our recent 2021 Corporate Debt and Treasury Report intending to include ESG elements in their next funding, and 35% of those specifically looking at it. on durable loans. In comparison, participation is much lower in Asia, where only sophisticated borrowers have the procedures and policies to tap this pool of capital.

The two fundamental (and related) characteristics of sustainable loans are:

  • the targets themselves, which are based on key performance indicators (KPIs); and
  • how their satisfaction is demonstrated and verified.

Some KPIs we see go beyond climate factors, although they are almost always combined with an environmental goal in sustainable lending. These benchmarks can include governance goals, such as board diversity or supporting clients to use resources wisely, or social goals such as increasing charitable giving.

There are typically two to four KPIs, which can be taken from across the ESG spectrum. KPIs often relate to traditional measures relating to reducing CO2 emissions and increasing the use of renewable energy and energy storage capacity. Third party certifications can also be used to facilitate comparability and prove objectivity; projects, infrastructure and buildings have a number of external certifications that can assess the sustainability of the construction, performance and renovation requirements of this asset, for example. At the company level, an improvement in a company’s sustainability rating could also be used to set sustainability goals.

Some KPIs we see go beyond climate factors, although they are almost always combined with an environmental goal in sustainable lending. These benchmarks can include governance goals, such as board diversity or supporting clients to use resources wisely, or social goals such as increasing charitable giving.

Where a borrower already publishes sustainability information in accordance with the recommendations of the Working Group on Climate-Related Financial Reporting (TFCD) or other established standards, KPIs can be closely aligned with the sustainability strategy of the organization. borrower. A union member will usually be appointed as a sustainability coordinator or structuring agent to help define key performance indicators acceptable to lenders and to ensure that the borrower’s goals are ambitious enough to counter any claims. greenwashing.

“The challenge will be to maintain the flexibility of sustainable lending products: Mark Carney, the former Governor of the Bank of England turned champion of sustainable investing, spoke of recognizing 50 shades of green in bringing economies to zero net.”

Rarely would a violation of a sustainability goal be an explicit default: instead, much of the control comes through reputation issues at the lender and borrower level. Lender policies and eligibility criteria will largely determine which borrowers can access sustainable loans, as well as the borrowing terms available. Lenders can exercise due diligence on factors outside the narrow scope of KPIs to reflect their own ESG policies to mitigate the risk of reputational damage, especially with respect to social factors and governance, and this diligence can be intensified in products related to sustainable development.

In addition, lenders may be required to report on their sustainability performance in their own investor information or annual reports. It is essential that loans that qualify as sustainable actually meet the relevant criteria and do so objectively. Verification of compliance by third-party reviewers or auditors is therefore a feature of many sustainable loans, especially when so-called “brown” industries are involved.

50 shades of green, possibly

Disclosures against TFCD recommendations are currently voluntary in most countries. However, the COP26 Private Finance Hub, an initiative to coordinate industry action around this year’s UN climate change conference, cited improving reporting and developing a strategy to implement TCFD more broadly within the framework of its four key objectives. Many large European companies already publish sustainability information according to certain TFCD benchmarks on a voluntary basis, producing sustainability reports that can be reviewed by their auditors.

However, for companies that do not, the time and costs associated with producing appropriate KPIs and demonstrating progress can be significant and far outweigh the benefit of relatively low pricing. ‘a sustainable loan. The move to mandatory TFCD-type disclosures, another aspiration of the COP26 Private Finance Hub, will increase the availability of this verified information and better align company policies with established ESG lending policies, which should allow more borrowers to tap this source of funding.

“Rarely would a violation of a sustainability goal be an explicit default: instead, much of the control comes through reputation issues at the lender and borrower level. ”

The challenge will be to maintain the flexibility of sustainable lending products: Mark Carney, the former Governor of the Bank of England turned champion of sustainable investing, spoke of recognizing 50 shades of green in moving economies to net zero . The much-vaunted EU taxonomy was developed as a classification system to help investors determine which activities are environmentally sustainable, but it is not an easy task for all businesses. The taxonomy is very prescriptive and technical and has taken a long time to develop.

So far, it has focused on the first two of its six stated main goals (climate change adaptation and mitigation) with some politically sensitive activities, such as nuclear power, being left out entirely. The UK intends to produce its own taxonomy, which could be more principled to avoid getting bogged down in stagnant administrative standards, but taxonomies have inherent limitations and have been fought elsewhere.

Various government and business initiatives aim to broaden the category of borrowers who have developed sustainability policies. However, it should be noted that there is a significant gap between borrowers who can access the trillions of dollars of ESG capital available globally and those who are not. Despite the boom in the market for durable loans, there is still some way to go before these loans are available to everyone.


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