Home Finance Sustainability-Linked Loans: Sowing the Seeds of a Greener and Brighter Future

Sustainability-Linked Loans: Sowing the Seeds of a Greener and Brighter Future

by internationalbanker

By Olivier Brien, Senior Manager, Global Solutions Consultant Lending, Finastra

 

 

 

 

Sustainability initiatives in financial services have been flourishing over the past few years. ESG (environmental, social and governance) is not a “nice to have” anymore but a crucial element in decision-making across all business areas. According to the “Global investor survey” conducted by PWC1 in 2021, nearly 80 percent of investors considered ESG a vital factor in their investment choices. Undoubtedly, ESG is now at the top of boards’ action lists. The multi-trillion-dollar opportunity for sustainable finance is vast and varied, encompassing a wide range of potential approaches, from providing financing to companies that lend money for retrofitting solar panels or transitioning to electric vehicle fleets to investing in firms that construct more sustainable buildings.

Looking back, Refinitiv LPC2 compiled data that showed a record-breaking increase in global ESG financing in 2021, reaching US$1.6 trillion, a 116-percent increase compared to the 2020 total. Another peak for green and ESG financing was recorded in the first quarter of 2022, at US$133 billion. Despite the global economic slowdown, the sector held up well last year.

Another recent study3 conducted by East & Partners in partnership with Finastra outlined how banks have been aiming for substantial growth by launching ESG-related products, particularly in Europe. More precisely, 76 percent of global banks planned to expand their involvement in green lending over the next 12 to 18 months and beyond. Green bonds (38 percent), sustainability-linked supply-chain finance (34 percent) and green-linked loans (33 percent) were the most popular ESG products mentioned.

Sustainability-linked loans (SLLs) present a fantastic opportunity for growth, enabling banks to play a role in improving the overall performance of a company thanks to attractive borrowing rates that act as incentive levers. The rates for SLLs are indexed to the company’s non-financial performance according to specific criteria—for example, its ESG rating—and their objectives should be ambitious and relevant to the borrower’s core sustainability and business strategy. When implemented in this way, banks can future-proof their own and their customers’ businesses while also contributing to society at large, as many countries around the world pledge their transitions to net-zero.

The complexities of sustainability-linked loans

A major challenge for banks is to grow their SLL portfolios while also being compliant with pricing, taxonomy and fee logic. These loans rely on complex pricing structures and variable elements that require regular monitoring against sustainability targets to meet contract objectives accurately. As banks use SLLs and credit provisions based on customers’ ESG credentials, they need capabilities to help corporates collect ESG data and access it through dashboards.

When conducted manually, these processes require significant resources and increase the risks of errors, longer processing times and higher costs. An EY study4 published last year indicated that more than half of respondents (55 percent) housed their ESG data in spreadsheets. There is a growing need for high-quality disclosures, and companies must accelerate their efforts and swap spreadsheets with automated data collection to mitigate these risks.

Inconsistencies in ESG reporting standards and regulatory uncertainties represent another challenge. Many initiatives are available that use different methodologies, scoring measurements and standards. In addition, all major market-data providers have developed their own independent ESG ratings based on different criteria and definitions of indicators, which can make pulling together objectives for SLLs that drive genuine change more difficult. Inconsistent ESG definitions within the company, forward-looking statements or reliance on estimates can also prove dangerous. Risks of greenwashing can be brought by investors or other third parties, with disclosures being misleading or false, whilst inaccurate omissions or misleading statements create liability risks and are more likely to attract attention from regulators.

To add to this uncertainty, according to the research5, corporate banks are still firming up the initial stages of their overall ESG strategies. Their primary ESG goal, cited by almost half (49 percent), is to reduce carbon emissions from their organisations. Banks are also concerned with defining terms such as ESG goals (43 percent); securing longer-term funding (44 percent); aligning the board, management and governance on sustainability initiatives (46 percent); implementing and updating their climate plans (27 percent); and harmonising ESG disclosures (26 percent).

To effectively support corporates with SLLs, banks must first develop and refine their ESG strategies to align with selected international benchmarks, the Science Based Targets initiative and their own values. While many companies share similar emissions targets, it is crucial for their roadmaps toward carbon neutrality to be grounded in factual, precise and science-based data.

Simplifying ESG and sustainability-linked lending

ESG reporting can seem challenging but provides an extraordinary competitive advantage for companies, fintechs (financial-technology firms) and financial institutions. As initiatives progress to make the global marketplace more standardised and banks better understand regulatory expectations, more companies will turn to SLLs thanks to their lower interest rates and flexible repayment terms.

For banks to deploy sustainable loans efficiently and at scale, investing in technology and automated solutions is crucial. Complexities in issuing SLLs and continuously evolving banking and ESG landscapes mean agile processes and future-proofed solutions are required to help manage ESG performance and pricing adjustments. For example, cloud-native solutions that simplify ESG and sustainability-linked lending by integrating Sustainability Performance Targets (SPTs) criteria into ESG pricing can help banks deliver better, sustainable lending experiences to their clients.

Automated KPI (key performance indicator) monitoring can help with all aspects of ESG, making it easier for banks to stay on top of their customers’ performance. Additionally, modern architecture and open APIs (application programming interfaces) can help banks leverage the flexibility they need to succeed in today’s ever-changing landscape. Thanks to open APIs, businesses can simplify their digital workflows, from data submission to application. They create a solid foundation for end-to-end digital journeys, allowing for easy progress tracking, approval requests and submission reviews.

Collaboration is of the utmost importance.

Collaboration is key to maintaining the level of agility required to adapt to new demands. As the SLL market grows and matures, fintechs can play vital roles in helping banks capture the opportunity. Banks must collaborate with fintechs to prioritise offering ESG-related lending solutions that will enable them to support ESG projects.

According to the Finastra study6, ESG heads have expressed that their top priority from fintech partners is the delivery of ESG-specific products that their banks can effectively use, satisfying the needs of many corporate clients for ready-made solutions as well as meeting their requirements. Additionally, the next largest area of demand is for products that aid in monitoring, which is becoming increasingly important due to the growing need for regulatory reporting in the ESG area. Approximately 10 percent of ESG heads said they require guidance from fintechs on carbon emissions, while a similar proportion seek clear definitional platforms that can provide insight into product development.

By offering tools that streamline access to ESG data and compliance with industry standards, fintechs and banks can work together to help corporates meet their sustainability targets and create a more sustainable future. Cloud-native SaaS (software as a service) solutions that use open APIs provide a high degree of flexibility to support varied deal structures and offer extensibility for the inclusion of new capabilities and partner applications.

In today’s world, it’s not just about claiming to be environmentally friendly but also proving it through collective action. We see a rapid evolution of ESG-disclosure requirements across geographies, all aimed at generating comparable, robust, quality and decision-helpful information. With this combination of regulation and technology, SLLs could play a major role in leading us toward a more inclusive, greener and brighter future.

 

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