Casting an eye over sustainability linked loans

Issuer and investor enthusiasm for SLLs has seen the market explode over the last two years. But, with stakeholder scrutiny set to grow, external verification will become increasingly important, say Jill Dumain, Simon Colton and Mariel Barrera Fermin of SGS

Environmental Finance: To what do you attribute the recent rapid growth in the SLL market?

Jill Dumain: It's a convergence of things finally coming together. There's a lot more transparency in society, so corporates want to be seen to be building their ESG credentials. Meanwhile, banks are beginning to understand that companies that are looking to improve their sustainability performance are likely to be good clients, while the banks themselves are under pressure from their shareholders to funnel money towards investments that are making a positive impact. All of this is in a context of societal pressure, of people wanting to see banks and corporations shift how they do business.

EF: What are the main challenges issuers face? What are the key pitfalls that issuers risk falling into when issuing SLLs?

JD: Corporate awareness has been slowly building over a number of years, developing a lot of expertise in measuring environmental and social performance and now, suddenly, there's lots of excitement. The risk is that corporations coming to the SLL market with a shorter history might come forward with targets that they think are ambitious, but which may not be from a societal standpoint.Simon Colton

The challenge is to bring them on a journey where their targets are ambitious enough to warrant a lower interest rate or better financial terms but, at the same time, not so difficult as to be discouraging.

Simon Colton: Issuers have to learn the language of sustainability and try to understand whether what they are proposing is plausible, as well as ambitious enough. This is where providers of second-party opinions and verification services come in. The banks can bring expertise in financial structuring, but a company such as SGS brings more than 140 years of experience in certification and verification and can help to put guardrails in place as the market is developing.

EF: How should issuers approach KPI selection? Is there a case for a standardised approach?

Mariel Barrera FerminMariel Barrera Fermin: KPIs have to be material to the company, they need to be measurable and meaningful. Carbon is usually a leading indicator here. I do think there's a case for standardisation, because such standards typically follow debate, review and a vetting process that brings a standardised KPI to the best possible point for the sector.

That said, there will always be room for customisation and the use of bespoke indicators. Every company is unique, and there are different factors at play in different regions of the world.

JD: This is particularly the case in developing countries where, historically, companies have had less access to capital and where, now, much of the environmental and social impact is taking place. It is vitally important that they can tap the SLL market, and standardised KPIs designed in developing economies may not be suitable.

EF: How should issuers seek to balance transparency with commercial confidentiality?

JD: On the financial side, there will always need to be some sort of confidentiality around pricing. In addition, there are elements of loans' sustainability characteristics that can be kept confidential – for example, a company might be trying something innovative, and it might make sense to be a little opaque until the concept is proven.

But it's often in a company's best interests to use an SLL to demonstrate what they're doing regarding sustainability. Transparency here can help improve a company's reputation and attract favourable media attention. There are also wider benefits to society in using corporate peer pressure to encourage competitors to improve their sustainability performance.

EF: What is the value-add of third-party verification? What are the limits to what verification can do?

Jill DumainJD: As we've noted, third-party verification can help sense-check the initial KPIs. And, because these loans are private agreements between the two parties, it's really valuable to show that the parties are happy to have someone else look at them, to show there's no collusion and nothing behind the screen to be embarrassed about.

But it's also important to acknowledge that the market is still in its early stages. There isn't any approval mechanism for a verifier and there are a lot of different levels of expertise out there. As the market develops, there's going to be greater clarity over who's doing a good job, whether KPIs were met or not, and which of the verifiers have the necessary knowledge and expertise.

EF: How do you anticipate the market evolving?

JD: I think the market is in a period of great excitement and it's going to shift to one of greater scrutiny and tighter controls. KPIs are going to be examined more critically. And the market will learn which models are successful, and which are less so. Within that process, I think we're going to see that external verification of SLLs will become key, for the reasons we've given above.

We've seen that in other areas of sustainability where, initially, you just trusted your partners because there was no other way to do it. But as legislation and legal liability are being introduced, we'll start to see financial penalties for companies making claims that don't stand up.

Jill Dumain is global vice president of sustainability solutions, and Mariel Barrera Fermin and Simon Colton are business development managers for ESG assurance solutions, at SGS. Email: