Growth in sustainability-linked loans boosts ESG ratings firms

NEW YORK, Oct 21 (LPC) - Increasing issuance of sustainability-linked loans by top investment-grade companies is boosting lenders’ reliance on independent ratings agencies to score and monitor firms’ environmental, social and governance (ESG) performance as investors call for greater transparency.

Sustainable lending is overtaking green loans as more companies with robust ESG strategies use key performance indicators (KPI) to measure carbon emissions reductions or water conservation metrics than can satisfy strict use of proceeds criteria that classify deals as green.

Independent sustainability rating firms have been scoring companies’ ESG performance for more than two decades, but third-party ratings are gaining importance as sustainability-linked loans gather momentum.

The Loan Syndications and Trading Association, Loan Market Association and Asia Pacific Loan Market Association developed Sustainability-Linked Loan Principles in March 2019 to guide lending, and issuance is climbing.

Global green and ESG-linked loans total US$92bn in 2019 so far, according to Refinitiv LPC. Of the 15 green and ESG loans announced in 2019, all but one have been sustainability-linked ESG deals, the data shows.

“The ESG-linked and KPI-linked facilities opened the game for any industry, adding value and giving visibility in the market to the companies’ commitments, by linking their sustainable strategy with their financial instruments” said Jorge Gonzalez Jacob, BBVA’s global head of corporate loans.

Sustainability-linked loans totaled US$71.3bn at the end of the third quarter of 2019, and have more than doubled from US$32bn of deals raised in the same period in 2018. Europe has taken the lead with 74% of green and ESG volume for the year to date, but pace is picking up in Asia (14%) the Americas (11%) and Japan (1%).

“These ESG/KPI-linked facilities provide more flexibility than the green loans since the use of the facilities is not limited to a specific green investment, on the contrary, they can be used for general corporate purposes,” Gonzalez Jacob said.


As sustainability lending develops, independent firms behind ESG ratings including Sustainalytics and Vigeo Eiris continue to be key players, as well as the ESG arms of bigger groups, including index providers MSCI, Refinitiv, and FTSE Russell, as more companies publish data on carbon emissions, water use and health and safety in annual reports.

Borrowers’ fears that sustainability loans might imply additional costs and administrative and legal workload in documentation and auditing are being eased as growth in the sector is cutting costs.

“That’s not the case - the credit agreement only needs to be slightly amended and the sustainability agency fees are limited, and recently have been further reduced as the sustainable market grows”, Gonzalez Jacob said.

The firms’ opinions on ESG risk and performance are linked to the interest rate of the loan, and allow borrowers to reduce their margins if they improve external ESG ratings or hit specific internal or external Key Performance Indicators (KPIs), or use both metrics.

“We are seeing varying approaches in the Sustainability Linked Loan space, from margins linked to external ESG scores to internal KPIs, or a blended approach drawing on both internal and external KPIs,” according to Charlotte Peyraud, VP of Sustainable Banking at Crédit Agricole CIB, who joined the bank from Sustainalytics. “During the target setting process it is important to identify ambitious targets that encourage meaningful sustainability performance improvements for the company,” she said.

Sustainability-linked loans have a pricing incentive, which can reduce margins by up to 5bp if they meet their benchmarks on finely-priced unsecured revolving credits and standby commercial paper backstop loans.

As ESG-linked loans increasingly rely on independent expert opinions, inevitable comparisons are being drawn between ESG ratings and credit ratings as lenders become more dependent on the information.

“It’s always better to have a third party involved, as it will reinforce the credibility on the whole process,” Gonzalez Jacob said.

The commercial relationship with an issuer entails a commitment to monitor and update companies’ ratings for the lifetime of the loan, Heather Lang, Executive Director for Sustainable Finance Solutions at Sustainalytics, said.

“Our ESG ratings have been used in close to 50 sustainability-linked loans. Companies, financial institutions and investors recognize our ratings and independence as key to credibility in this market,” she said.


The space is getting more crowded as traditional rating agencies try to incorporate ESG ratings into the credit rating process. Moody’s Investors Service acquired a majority stake in Vigeo Eiris in April, with the aim of promoting global ESG standards. S&P bought TruCost in 2016 and created the S&P Dow Jones ESG index earlier this year, which gives companies ESG scores that measure financially material factors.

Unlike credit ratings agencies, ESG ratings are currently hard to compare due to a lack of standardization, which is making it difficult to compare companies against their peers. Regulation may be required, however, to create the certification and compliance that will aid and speed analysis, sources said.

ESG-linked financing is still subject to different methodologies and taxonomies, but the Sustainability Accounting Standards Board (SASB), the leading Global Reporting Initiative and the Task Force on Climate-related Financial Disclosures (TCFD) are emerging as ESG standard setters as the drive to meet the UN’s sustainable development goals by 2030 accelerates.