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ESG & Sustainability Insights

Banking Brief: a sustainable success

6 minute read

Sustainability-linked loans have been around for a while, but the current economic climate is set to boost investor appetite once again, according to participants speaking at the fourth webinar in this series.

The market for sustainable finance is proving to be remarkably resilient, despite the interruption caused by the pandemic. And in fact the global reset that will likely follow the virus’s impact should help the market and appetite for environmental, social and governance (ESG)-led loans to grow. 

“Initially, I think people were worried that the pandemic would slow things down,” said Caroline Haas, head of Sustainable Finance, Financial Institutions and SSAs at NatWest Markets.

“But when I speak to investors about their ESG plans, nothing is slowing down – in fact it’s continuing, aggressively. If you look at the EU recovery plan and the focus of that, it’s environmentally and socially sound. And that’s not slowing down.”

Haas’s optimism was matched by NatWest’s Loan Markets director Nathan Holland, who said that while the short-term impact of coronavirus hit levels of loan issuance and refinancings in Q2 2020, the bounce back has begun. “We do expect sustainable loan volumes to return to higher levels later this year, as refinancings come back to the market.”

Given that the size of the global market last year approached $150bn – in large part driven by corporates converting their existing revolving credit facilities into sustainable loans – then it’s clear to see how exciting the opportunities are in this space.

“In the face of increased scrutiny from investors, lenders, regulators and the media, helping fund managers to put ESG at the top of their agenda will be critical”

Swati Baheti, vice president, Loan Markets, NatWest

Holland reported that within that overall trend upwards, some particular areas of growth were notable. “We are seeing a growing focus on the ‘S’ and ‘G’ parts of ESG, with more socially and governance-focused loans, and where borrowers are more concerned with those outcomes. Indeed, 25% of the KPIs [key performance indicators] of new sustainable loans are now social or governance-related, compared with around zero two years ago.”

That, Holland said, sits alongside the trend for more KPIs being attached to sustainable loans. While previously it wasn’t uncommon for a new issue to have just one ESG KPI: “Now it’s not uncommon to see two, three, four or even five KPIs being used for a sustainable loan.”

What is driving the growth of the sustainability-linked loans market?

Looking more broadly, the picture painted was a positive one, as the volume, spread and sophistication of sustainability-linked loans continues to grow. And there are several drivers behind this, explained Haas.

“We see three key drivers. The first is that the borrower is looking to show their sustainability strategy, usually in response to a push from equity investors to do that. That’s a natural way to show they are supporting sustainability.

“The second driver comes from the banks themselves. Again, they are being asked by their equity holders to demonstrate their commitment to the sustainable agenda.

“And then the asset owners are asking for this, with both younger managers and older ones with an eye on their legacy taking a lead. Add that to greater interest in sustainability in the investor relations area, and you see how this grows.”

For many observers, however, the widespread adoption of ESG-led loans has been hampered by a lack of widely adopted or inconsistently applied KPIs. And that is especially true in the funds sector. “A lot of the characteristics of well-regarded KPIs are that they accurately reflect a sustainability strategy and are meaningful; and they embody targets that are ambitious,” said Swati Baheti, vice president, Loan Markets at NatWest.

“In terms of funds, we expect that to be reflected in a stronger focus on the governance aspects of loans. That’s key for fund managers to demonstrate their focus on this area as a way of achieving value protection and creation.”

A consistent approach

But, Baheti pointed out, consistency is key. “Fund managers really want to see a set of consistently applied KPIs on these products, and in effect to be able to overlay one overarching strategy over their entire portfolio. They also want to see proper disclosure of ESG KPIs, and that will really help fund managers do better.”

And the fund finance market is just getting started in using and driving ESG. “But the opportunity to drive change is definitely there,” said Baheti. “And that’s driven by the general move towards greener, cleaner investment, with investors increasingly vocal in calling for that. In addition, more rigorous reporting of ESG outcomes will help.

“Second, as more focus falls on ESG reporting it becomes a question of how that’s reflected in financing documentation and how they can use their ESG targets to market their services.

“Third, boards are demanding more attention to this as financial stability becomes more closely linked to the sustainability agenda. In the face of increased scrutiny from investors, lenders, regulators and the media, helping fund managers to put ESG at the top of their agenda will be critical.”

Concluding, Haas made it clear that the gains made so far shouldn’t be abandoned as we strive towards a return to something like normal life. Despite the challenges, she remained optimistic.

“As hard as coronavirus has been, it has given us the chance to stop and think a little bit about how to work with new models. And I really hope we don’t take a step back to old habits and instead think about how we can build a sustainable future – how we can use these tools in a robust way and make sure we avoid greenwashing. It’s a great opportunity to see the benefits and do things differently.”

By Chris Torney