The green and sustainability loan market: ready for take-off

Green and sustainability loans are the hot new trend in sustainable finance. Could they outgrow the booming green bond market, ask Nick Roumpis and Peter Cripps

The green loan market passed a significant milestone in its evolution in March, with the launch of the Green Loan Principles (GLPs).

These are closely modelled on the Green Bond Principles (GBPs), which were launched in 2014, and helped secure a sustained period of rapid growth for the market.

Just like the GBPs, the GLPs are designed for lending with a dedicated green use of proceeds, and they recommend transparency about how the projects were selected, the funds allocated and the impacts reported.

However, at the same time as the green loan market has taken off, another sustainability-themed loan product has emerged.

These have been issued under various labels – such as sustainability, impact, or environmental, social and governance (ESG) – and their interest rates are often contingent on the companies' ESG scores or other sustainability-linked factors.

Cecile Moitry, director of sustainable finance and investment at BNP Paribas, explains: "They are fundamentally different. Green loans are based on the Green Loan Principles (GLP) and the idea of a dedicated use of proceeds to finance a green project or capex.

"Positive incentive loans, or ESG-linked loans, do not have such a dedicated use of proceeds but include the notion of performance according to ESG criteria, with a reward in terms of pricing according to the performance."

Loans issued under the GLPs tend to be term loans, explains another market insider, because this type of loan is often used for a specific project or acquisition, whereas the sustainability loans tend to be for general corporate purposes.

However, there is no standardisation of definitions. Labels are used differently for different deals.

For example, Dutch health and nutrition company Royal DSM was a borrower on a green-labelled deal, but this did not have a designated use of proceeds.

The interest rate on its €1 billion ($1.2 billion) revolving credit facility depends on the following three elements: improving its cumulative greenhouse gas (GHG) efficiency, improving its score according to an 'energy efficiency index' that measures energy intensity, and the amount of its electricity sourced from renewables.

Royal DSM's auditor will assess the progress of the company against these targets annually.

In other words, it is more like an ESG-linked or a sustainability loan than a green loan in its structure.

Looking at these various types of green or sustainability-themed loans together, they are now worth some $32 billion since the first transactions in early 2017, according to data compiled by Environmental Finance (see table for selected list of issues).

"As there are not enough green bonds to cater for demand, we are seeing green investors and larger investors that increasingly allocate part of their mandate to green finance become attracted to the green loans market" - Leonie Schreve, ING

Some market watchers believe the green loan market could become bigger than the green bond market. To put that in context, the green bond market saw about $175 billion of issues in 2017.

According to Societe Generale, the market could yet grow ten-fold.

One banker said that "probably as of today there are 40 deals that we know of, but it doesn't mean that we know of all the deals, and some of them are under discussion."

These loans have great potential in regions where the loan market dwarfs the bond market. For example, Eduardo Francisco, president at BDO Capital & Investment Corporation, told Environmental Finance's Green Bonds Asia conference that in the Philippines the local currency bond market is just a sixth the size of the loan market.

"I would not be shocked if 10 or 20% of that is green, and it's just that we are not reporting it," he added.

"The financing of green loans has so much more impact for developing countries." This rapidly growing market has attracted major corporates such as French food firm Danone (which borrowed €2 billion), Dutch health technology firm Royal Philips (€1 billion) and Spanish utility Iberdrola (€5.3 billion).

The phenomenon started in Europe but has now been adopted as far afield as Asia, Russia and the US, with companies such as Avangrid, Polymetal, and Wilmar tapping the market.

Green Loans

For corporates, green loans are a way of communicating their sustainability strategies and engaging in a conversation on sustainable finance.

Bruné Singh, group treasurer at Royal DSM, told Environmental Finance: "We concluded this revolving credit facility to underline our commitment to tackling climate change specifically.

"We also see this transaction as an opportunity to collaborate with our banking partners and lead the conversation on sustainability and climate change, and influence mindsets.

"We haven't tried to reinvent the wheel here, we are simply using this transaction to express what we are already doing.

"There is a universe of green investors, and until recently the only investments they were able to put their money into was green bonds" - Clare Dawson, LMA

We are embedding existing criteria to align with our overall approach on the topic." The creation of the GLPs is significant because it is expected to help the market for green loans scale up.

It also marks the first time that learnings from the green bond market have led to the creation of another asset class within sustainable finance.

Tallat Hussain, senior counsel at White & Case, said of the launch of the GLPs: "This new categorisation framework may inject the necessary integrity required to encourage instruments like green loans to be the new shape of green finance. It may also set the groundwork for innovative projects and financial solutions."

The GLPs were formed by the Loan Market Association (LMA), which covers Europe, the Middle East and Africa, and the Asia Pacific Loan Market Association, with the help of the International Capital Market Association, which administers the GBPs.

Clare Dawson, CEO of the LMA, told Environmental Finance: "We deliberately based the GLP on the GBP because we didn't want to create arbitrage between the loan and bond principles. The GBPs were well established, so there was no point in reinventing the wheel.

"Another consideration was the fact that it is also possible to securitise loans into the bond market, so you would want the underlying loans to be following the same principles as the bond resulting from the securitisation."

In this way, the creation of the GLPs is expected to help the green bond market scale up, too.

It is generally felt that the green loan market is complementary to the green bond market, rather than cannibalistic, although it could lead to double counting of green assets, which might be initially counted as part of a green loan, and then securitised as a bond.

However, there are some practical differences between the two sets of voluntary principles. For example, because loans are private, the level of reporting in the public domain may be slightly less than for bonds, Dawson explains.

"Lenders may also consider self-certification rather than external review to be appropriate," due to the close relationship between lender and borrower.

Dawson revealed that the LMA and APLMA have had discussions with the Loan Syndications & Trading Association (LSTA) based in the US, "and we will be working with them in future as we look to develop the Principles".

"The Principles currently effectively contemplate term loans and use of proceeds. We are going to be looking to develop them to be applicable to more general purpose loans – so looking at how you measure the greenness of the loan not based purely on the specific use of proceeds but looking more broadly at the company.

"That's the next stage, which will broaden the possibility of doing a loan under the Principles." She explains that this would be significant in terms of helping to expand the Principles to a wider group of borrowers.

"If you can apply green principles that allow borrowers to use a revolving credit facility under a green structure, then you are going to broaden the universe of borrowers. This is particularly the case for small-to-medium-sized borrowers because often they don't have specific projects to which they can allocate the funds, which is what is required for a green bond or a green term loan based on use of proceeds."

Sustainability loans

Sustainability loans – in the form of various labels – are typically lent for general corporate purposes.

Each deal is different, but the interest rate is often variable, according to defined sustainability factors, in order to encourage some form of improvement in the sustainability performance of the borrower.

For the lender, it can justify a slightly lower borrowing cost based on the premise that by improving its sustainability rating, the lender is at lower risk of default.

Normally companies and banks do not disclose the pricing details of their green and ESG facilities.

According to Leonie Schreve, global head of sustainable finance at ING, discounts and penalties tend to vary between 5% and 10% of the interest rate.

"As the bar for sustainability is raised all the time, companies with a very high score will find it more difficult to make significant improvements than companies with an average score," said Schreve.

However, transparency is an issue for sustainability loans.

Lenders are often happy to issue press releases announcing that they have signed such a loan, but the details on the sustainability criteria on which the interest rate hinges can be vague.

For example, Danone linked its €2 billion syndicated credit facility with ESG criteria. This transaction, which was reported in February, was hailed at the time as "the future of banking" by Yann Gerardin, head of corporate and institutional banking at BNP Paribas.

Danone's facility now includes "an innovative mechanism" of payable margin adjustment, reviewed at least once per year based on ESG scores from Sustainalytics, Vigeo Eiris and B Lab, a non-profit providing certifications to companies that meet rigorous standards of social and environmental performance, accountability and transparency.

"ESG can be a very generic phrase, depending on what's actually being measured" - Cary Krosinsky, Real Impact Tracker

Cary Krosinsky, a lecturer at Yale College and president of Real Impact Tracker – an organisation looking at the impact that fund managers have on ESG – told Environmental Finance at the time: "While this is great to see in general, ESG can be a very generic phrase, depending on what's actually being measured.

"For example, Danone is a company with potential future fresh water access risk. Will that be part of the assessment?"

A spokesperson for Danone told Environmental Finance that fresh water access is part of all sustainability indexes as well as B Corp assessments. It referred to Sustainalytics and Vigeo Eiris websites for more information on their ESG methodologies.

In another deal, Italian insurer Generali linked €4 billion of credit facilities with green targets and progress made on sustainability initiatives. But it declined to provide more details about the specific targets and factors that would be taken into consideration.

Schreve at ING said: "With the launch of the LMA Green Loan Principles, transparency and clarity on green loans has been achieved by standardised methods of reporting.

"I would expect more transparency and a bit more standardisation on what is green and reporting on a regular basis during the tenure of the facility to ensure those criteria and commitments are being met."

A spokesperson for LMA said: "This [transparency] will no doubt be an area for development going forward, although it should be noted that there are already well-developed standards in the market, such as those developed by the Climate Bonds Initiative, which specify clear criteria for what is required to achieve, for example, solar energy certification.

Investor diversification

One of the most exciting aspects of this fledgling green and sustainability loan market is its potential to appeal to 'non-bank investors' who are being driven by a green or sustainability mandate to diversify the assets to which they allocate their capital.

ING's Schreve said a supply shortage in the green bond market could boost the green loan market: "As there are not enough green bonds to cater for demand, we are seeing green investors and larger investors that increasingly allocate part of their mandate to green finance become attracted to the green loans market.

For green loans, there is very good potential for more parties to step in as investors besides the traditional lenders."

LMA's Dawson agrees: "There is a universe of green investors, and until recently the only investments they were able to put their money into was green bonds.

"So, to the extent that they are allowed to invest in loans – some types of nonbank financial institutions have regulatory restrictions on how much they can put into loans – the emergence of a green loan market gives them an alternative to buying bonds."

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