11 September 2023

Taking stock as the market prepares for growth

As borrowers and lenders take stock of measures to improve transparency and robustness in the sustainable loans market, ING's sustainable finance experts remain positive that the recent slowdown is a temporary pause as a stronger market emerges

Environmental Finance: How are regional trends converging or diverging in the sustainable loans market?

Robert Spruijtmanaging director, head of sustainable finance EMEA at ING: In Europe, we see that despite an overall drop in the sustainable debt market due to rising interest rates, increasing numbers of banks continue to integrate sustainability into financing. However, every bank has a different view on how to go about it, so you see some deviation in terms of how specific topics are being addressed in the sustainable loans market. The update on the guidance on Sustainability Linked Loan Principles (SLLP) in February 2023 has brought more harmonisation and transparency to the market, particularly with the necessity to have external verification of a loan provided by a relevant expert such as an auditor, consultant, or agency. We are also seeing more scrutiny from the European Central Bank with regards to integrating ESG materiality into risk models.

Another trend has been the move away from an ESG rating sustainability-linked approach towards linking the structure to specific KPIs. The ESG rating-linked approach is a good starting point for companies that are not yet ready to set specific KPIs as it still requires a company to improve its disclosure and governance structure. However, once companies move onto the next phase of building a materiality matrix to identify ESG risks then they can set specific targets and incorporate KPI-linked financing.

Alina Carolina OliveriaAna Carolina Oliveira, managing director, head of sustainable finance Americas at ING: North America faces unique challenges with anti-ESG sentiment making borrowers tread more carefully. This caution has impacted lead times. In the past, you could have easily completed a loan with sustainability-linked features within two to three months. Now, it is more like six months – sometimes even nine. Lenders and borrowers are cautious to pick the right metrics and targets to help mitigate greenwashing concerns. That is a positive overall but, given the polarisation of the topic in the US, the process needs to be conducted in a way that doesn't create any further friction.

Despite these challenges, we are seeing encouraging trends. For example, many sustainability-linked structures are coming up for refinancing for the first time. Almost 100% of our clients have decided to keep the structure.

The structure is becoming stronger as well. The gradual move from ESG ratings towards KPIs – especially for borrowers more advanced in their ESG journey – is an improvement. Furthermore, those who had chosen KPIs that were purely operational, such as Scope 1 and 2 greenhouse gas (GHG) emissions, water or (renewable) energy consumption, are now looking at KPIs related to the impacts of their products and their supply chains.

The above leads me to believe the slowdown in the market is a temporary period of realignment as it moves to a stronger position.

Martijn Hoogerwerf, managing director, head of sustainable finance APAC at ING: In line with global trends, the sustainable loan market in Asia Pacific saw a significant drop in the past six quarters. The largest Asian country for sustainable finance is Greater China, comprising of 40-50% of the Asian sustainable loan market, followed by Australia, Singapore, and Japan. In the first half of 2022, Greater China had $17 billion in sustainable loan volumes, whereas that dropped to $4.5 billion in the first half of 2023. We see that the current interest rate environment is leading Chinese corporates to refinance offshore transactions with onshore revolving credit facility (RCF) loans. There is a bigger incentive to do sustainability-linked loans (SLLs) offshore because demand for sustainable structures is higher there. Whereas onshore there is less incentive and some of the financings are being done onshore as regular RCFs.

On the upside, we have also seen clients and banks across the APAC region take longer to structure transactions and come to market as they seek to make their sustainable structures more robust. There is a perception that Asia is behind on its sustainability journey but it's a very diverse region and there are some countries, such as Australia, that are further ahead than others. At ING, we have put a regional coverage model in place with sustainable finance resources in countries such as Australia, South Korea, and Hong Kong to be able to address this diverse region in the most optimal way.

EF: How are science-based targets being incorporated into structures?

RS: The pivot to science-based targets across the SLL market is a good development. Scope 3 targets are proving to be a challenge as companies struggle with collecting the data they need. However, we expect the Corporate Sustainability Reporting Directive (CSRD), will provide more data points. This will be further supported by the Corporate Sustainable Due Diligence Directive (CSDDD), which requires (as per the latest draft) companies to assess climate and human rights risks within their company and across value chains. We expect more data collection for Scope 3 off the back of that.

The upcoming reporting requirements such as the International Sustainability Standards Board (ISSB) and CSRD will also help financial institutions understand how their clients are transitioning and what they are identifying as material in that journey. We expect this to give financial institutions better tools to engage with clients.

ACO: The emissions-related KPIs of sustainability-linked bonds (SLB) are typically only checked once in the lifespan of a product. In SLLs, however, this is an annual exercise. For Scope 3, you must therefore look at the emissions of all your suppliers and products each year. This is complicated to forecast. As companies are only just starting to collect this data, we face some resistance from companies to adopt annual Scope 3 targets. Borrowers are at a crossroads: if your targets are too ambitious you might not get internal buy-in to implement them at the timeline dictated by your credit facility. However, if you settle on incremental improvements only, you might be seen as not ambitious enough. This dilemma will vary per sector, borrower size, and location but I don't see it going away anytime soon.

EF: What is best practice for syndication in this space?

Martijn HoogerwerfMH: At ING, we have always tried to challenge coordinators and clients on certain instructions or structures. However, even just a couple of years ago, participating banks would seldom have many questions about the structure. Nowadays, banks go through more extensive due diligence. That is driving the market in the right direction. If your name is on that transaction, you want to make sure it is as ambitious and material as possible and in alignment with the SLLP.

ACO: ING's approach seeks engagement rather than disengagement, as sitting at the table allows us to use our influence to change structures where we are not coordinating. Importantly, compliance with the SLLP is a non-negotiable starting point and our goal is to participate more actively in the structuring next time.

There are cross-jurisdiction challenges to navigate as well. In Europe, you usually need 100% of the banks to agree to any changes after the facility has closed. In the US, you typically just need a majority of the lenders to agree. So, if you have a cross-jurisdictional syndicate then you must navigate those different jurisdictional dynamics and regulatory requirements. The overall intention of the group of lenders is to achieve the best outcome possible for the group but there can still be a difference in views given the different market dynamics in each region.

EF: What trends are you seeing for use of proceeds versus sustainability-linked loan structures?

ACO: Green is king, and the use of proceeds (UoP) structure continues to reign supreme. I think that will continue in the US given the expected impact of the Inflation Reduction Act. I am also seeing an emerging trend for hybrid structures which add an incentive to a UoP structure, typically across two tranches. You can offer lower pricing for the green loan tranche and keep regular pricing for the tranche that is not green.

MH: I quite like those structures. We've done a few transactions in Asia where a general RCF has a green tranche. This can be useful for hard-to-abate companies. It allows for some flexibility and you can price that tranche a bit lower.
That's the other big theme that still needs to be tackled; whether the pricing of sustainable structures will be regulated versus non-sustainable finance structures. Pricing benefits have been voluntary thus far. Another question is whether central banks might want banks to put aside more capital for carbon-intensive loan activities. We expect these topics to be addressed by regulators in the next few years.

EF: How are social KPIs being incorporated?

Robert SpruijtRS: The market is still very focused on emissions only. However, we must also take social elements into account. We are strong advocates for including social elements in KPIs. With CSRD, companies will need to assess the most material risks in their business models and, consequently, we expect it to be less common for companies to structure SLLs based purely on emissions. The SLLP will also drive this as they help identify multi-material elements.

MH: The social UoP loan market is a fraction of the green UoP market here in Asia. And, for SLLs, if you see a social KPI added it is usually around health and safety or gender balance. In Asia, a large part of the region lives on two dollars a day. The sustainable finance markets need not only to address and support the climate but also social elements in the transition to a lower carbon economy.

ACO: In the Americas, we have seen the topic of digital inclusion popping up in the telecoms sector, for example. Previously, a fibre or data centre company would simply look at energy efficiency and renewable energy use. Now companies are saying they want to bring fibre to underserved areas so that these populations can have better access to education and training. We are starting to see more KPIs aimed at providing positive impact to targeted populations or regions.

EF: How does the sustainable loans portfolio at ING fit into the bank's wider net-zero journey and sustainable finance targets?

RS: We finance a lot of sustainable activities, but we still finance more that is not. However, society, our clients and we are moving to a low-carbon economy. We are a part of the Net Zero Banking Alliance (NZBA) and have our own net zero and sustainable finance commitments. On top of that, we are mapping the transition plans of our clients so that we can engage with those clients that don't have a proper plan in place. I expect that to be a trend going forward as financial institutions look at their portfolios in relation to the net-zero trajectories they have committed to. Those companies that do not transition effectively could face challenges in obtaining liquidity in the longer term. The Alliance is currently comprised of over 120 banks which own $70 trillion worth of assets, currently representing over 40% of global banking assets. Banks can have a significant impact on net zero if it is properly implemented.

MH: I think sustainable finance can go further on connecting the dots with net-zero commitments. For example, in the shipping sector, we have the Poseidon Principles, to which ING is a signatory. ING also worked on the Sustainable Steel Principles, and the same is being developed for aluminium and cement. Market-accepted decarbonisation trajectories and objectives allow us to apply those principles to our own net-zero commitments and our sustainable finance portfolios.

This is particularly relevant for hard-to-abate sectors as it is clear that capital is required to allow those sectors to decarbonise. 

For more information, see: www.ingwb.com/en/sustainable-finance

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