A new financial product has emerged that provides a direct link between sustainability performance and financial value to the business. George Blacksell asks if this could be a game changer for the future of corporate sustainability?
Recognition that sustainability is good for business and for investment returns in the long-term is now widespread – with 93% of CEOs seeing it as key to overall success.[1] Though sustainability may be fast becoming an established business principle, translating the theory into practical financial value remains a challenge.[2]
Investors agree. Just 7 percent of them believe that businesses can accurately quantify the value of sustainability initiatives.[3] Existing proof-points tend to be figures from academic studies, far removed from the everyday. The emergence of a new approach to an age old financial product, however, demonstrates a direct cause and effect relationship between sustainability performance and the cost of capital to an individual company – sustainable lending.
What is sustainable lending?
Businesses often seek funds from external sources to dedicate finance to new projects and invest in future growth. Bank loans, as a form of debt capital, provide one such way of doing so. The new sustainability loan concept links the interest rate of the bank loan, i.e. the cost of capital, to meeting pre-agreed sustainability performance targets. In other words, the better sustainability performance demonstrated by a company the lower interest rate it gets – thereby reducing debt financing costs. Hey presto! A demonstrable business case that every CEO and CFO can sink their teeth into.
Sustainability-linked loans are different from existing green loans and bonds. Firstly, because they can be used for everyday corporate purposes – for green bonds and loans the proceeds are earmarked to only fund projects with positive environmental benefits. Secondly, because their rate of interest is not fixed (usually the case for bonds) and is linked to broader corporate performance against Environmental as well as Social and Governance criteria (ESG).
A number of European banks now promote their offers of sustainable credit facilities, in particular BNP Paribas and ING. One of the first examples of this new approach was led by ING and the Dutch technology company, Philips. Both parties agreed a €1bn loan facility in April 2017 with the interest linked to the ESG rating assessed by Sustainalytics, as an independent third party ratings agency. Although ING was the Sustainability Coordinator of the facility, it was a syndicated loan agreed with a consortium of 16 other banks. This is significant as it showed institutional clout behind the concept, with backing from American multinationals such as Morgan Stanley and Goldman Sachs.
Danone followed suit earlier this year with a loan facility led by BNP Paribas. As part of this agreement the rate of interest was linked to two goals:
Performance against ESG criteria as assessed by ratings agencies Sustainalytics and Vigeo Eiris
Percentage of consolidated sales of Danone covered by Benefit-Corporation (B Corp) certifications – see more from my colleague on the B Corp movement and certification here.
The loan was featured front and centre of mainstream investor communications, first announced in Danone’s FY 2017 financial report (pg. 7). It was the CFO, Cécile Cabanis, who said of entering into the credit facility agreement that it is: “Consistent with Danone’s ambition to become a B Corp and with [its] long-term commitment to create sustainable value for our shareholders and all our stakeholders.” The win-win scenario for business and society here is compelling, with financial lenders forming part of the deal agreeing to reduce loan margins, impacting the interest rate in turn, by as much as 20 percent if Danone meets both of its sustainability goals.
Why so sustainable?
What are the benefits of sustainable lending for both the borrower and lender over and above a usual bank loan? One of the primary drivers is that it demonstrates innovation and a commitment to adapting business models to a changing context. CFO of Philips, Abhijit Bhattacharya, said its partnership with ING “underlines our commitment to sustainability as an integral part of how we do business.” According to Gerro Goedhuis, ING Head of Syndicated Finance, the new loan structure “emphasises that ING is at the forefront of innovating the syndicated loan market—a position that we wish to expand.”
From the bank’s perspective, positive ESG performance provides an indication of good management quality. Annual third-party verification of performance against criteria that the bank deems financially material should, therefore, ensure that the corporate borrower represents less of a credit risk.
Further to this, companies confident in their ability to meet sustainability-related performance targets will see this translated into a lower cost of capital. On this basis, it is not hard to see why firms such as Philips and Danone pursued this credit facility, both being widely regarded as leaders in sustainability. What is encouraging, however, is that these loans are of interest to companies with high ESG risks. Olam and Wilmar, both large palm oil producers, also each individually partnered with ING on creating their own loan facilities. This shows that both are willing to be held financially accountable to performance on ESG factors, despite the complex risks they face. It also acts as an indication that both parties think that the performance targets set represent a realistic ambition.
A bright future?
Sustainable loans are an exciting development in the ever-growing market of environmental finance. The fact that the incentives they provide speak directly to the CFO, investors relations, treasury and sustainability departments is what makes them particularly attractive. It appears that momentum is building – since ING’s first sustainability-linked loan last year it has led on more than 15 others. According to Yann Gerardin, Head of Corporate and Institutional Banking at BNP Paribas, this is where banking is headed. “A transaction that demonstrates that delivering on sustainability will ultimately drive economic performance? Yes, this is the future of banking.”
With a business case that can be proved in the near term, it might just be that sustainable loans represent the future of corporate sustainability to boot.
George Blacksell is a Consultant at Corporate Citizenship.
[1] The United Nations Global Compact-Accenture Strategy CEO Study, 2016
[2] 50% of US executives cite “difficulty measuring performance / quantifying benefits” as a reason for not investing more in sustainability initiatives
[3] The UN Global Compact-Accenture CEO Study on Sustainability, The Investor Study: Insights from PRI Signatories, 2014
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