What if the CEO asks me... about ESG-linked financing facilities

As focus moves from short term lockdown liquidity on to longer term financing needs, loan facilities linked to ESG and sustainability targets are back in the news.

But what's in it for you? Is this just good PR, or are there wider corporate benefits to be considered with this sort of loan? And with Coronavirus emergency loans to be refinanced in the coming months, do ESG-linked facilities really open up new financing options for borrowers?

The background – what is an ESG-linked facility?

The concept of "green lending" is not a new one. Until recently it meant financing environmentally friendly projects, like renewable energy production. In recent years, with the UK's commitment to achieving net zero emissions by 2050, and growing political and consumer will to tackle climate change, environmental issues have become critical to decision making.

This has caused a rapid expansion over the past 5 years in a broader category of green finance, as lenders and borrowers each see the benefits in linking their debt finance to environmental issues, as well as diversification into ESG finance, which also takes account of wider social and governance targets.

As global economies focus on a green and sustainable recovery, investors have continued to move to ESG markets, with ESG-linked assets expected to make up a third of all investments by 2025 (more than US$50 trillion).

Is there a "standard" ESG-linked facility?

There's no standard version of an ESG-linked facility, but trade bodies representing loan, bond and investment markets have all produced standard documents which allow their members to introduce ESG targets in their documents to facilitate ESG-linking.

Typically these involve the borrower being set a performance target by the lender(s) or investors, similar to a financial covenant, but focussing on an ESG target like the level of the borrower's CO2 emissions. In other examples, ESG targets may include use of water or plastics.

Although a lot of the publicity around ESG-linked facilities focusses on the Environmental side, facilities linked to Social and Governance criteria have also become more commonplace, with targets including the number of women or ethnic minorities on the borrower's board.

Under the terms of the loan facility, the borrower is then rewarded for meeting these targets, usually with a lower margin or interest rate payable on the loan. In simple terms, the borrower gets a financial incentive from its lenders / investors when it hits the agreed ESG targets. In some cases, the borrower may then choose to apply the money it saves in interest payments towards other ESG objectives, further enhancing its ESG credentials.

Recent examples

Earlier this year, several retailers announced new ESG-linked loan facilities, including Joules (a £25 million revolving credit facility and £9 million term loan with Barclays, linked to performance against three sustainability performance targets) and Kingfisher (a £550 million revolving credit facility with a syndicate of banks, with a margin which decreases if Kingfisher achieves specific targets aligned with a responsible business plan).

In both cases, the signing of the new loan facilities were accompanied by a press statement from the CFO, and publicity around how the company was acting responsibly and improving its environmental performance.

The story is similar internationally, with Australian supermarket group Coles recently announcing that it has entered into the first sustainability linked loan in Australia with ANZ, BNP Paribas and Rabobank.

What's in for me?

The benefits of ESG-linked facilities can be split into two categories – financial and wider corporate benefits.

On the financial side, the headlines are often grabbed by the reductions in finance costs (usually through reduced interest rates) which can be achieved under the terms of the facility. While the reduction in margin may be welcomed, particularly when it's tied to a sustainability target which you have already set in your business plan, the real benefit may come through attracting new investors or lenders to the business. Although the recent examples involved high street banks, the recent flood of funding into ESG investments means non-bank lenders have money to spend and are looking to lend to borrowers with ambitious ESG targets.

On the wider corporate side, the gains from showing your environmental and wider ESG credentials are clear to see. As we're part way through a busy year for all things ESG, with COP26 still to come in November, public sentiment for environmental issues is stronger than ever. Consumers are becoming more knowledgeable on ESG issues, and sophisticated in their requirements from retailers, and increased regulation and reporting requirements mean you will be expected to prove your credentials and avoid green-washing. Showing that an ESG focus flows through your business, from supply chain to shop floor, and including finance issues like insurance and loan facilities, is becoming essential. Getting caught on the wrong side of the ESG line can be increasingly damaging to business, and an ESG-linked facility may be a relatively easy step towards becoming a more modern and progressive business.

The information in this publication is for guidance purposes only and does not constitute legal advice. We attempt to ensure that the content is current as at the date of publication, but we do not guarantee that it remains up to date. You should seek legal or other professional advice before acting or relying on any of the content.