February 22, 2022 - The enthusiasm for sustainable finance has not waned in 2022. Refinitiv LPC recorded over $40 billion of announced sustainability linked loan volume globally six weeks into 2022, up more than 50% from the $25.6 billion raised during the same period last year. This increase comes on the heels of the banner year 2021 was for sustainable finance.  According to Refinitiv LPC, global sustainable finance (bonds and loans) reached $1.3 trillion in deal volume, a 116% increase over year-ago totals and a new record.  There were several standout products in 2021, including social bonds, sustainable bonds and sustainability linked loans.  The global loan markets hit a new record with over $681 billion of green and sustainability-linked lending last year, a 275% increase over the $181.7 billion raised in 2020. Of that volume, sustainability linked loans accounted for more than $600 billion, a new record and an increase of 3.5 times the level reached in 2020. Where EMEA has consistently led the pack on activity, the U.S. was especially active in sustainability linked loans in 2021.

This trend demonstrates the increased focus on ESG issues by investors and companies, and clearly the relative flexibility of the sustainability-linked loan structure – there is not use of proceeds requirement – has proven attractive. Indeed, it was reported in the Green Lending Review that “almost all loan financings now include a discussion of ESG metrics, with both leveraged and investment grade issuers weighing options.” Sustainability-linked loans’ hallmark feature is the link of the borrower’s sustainability performance to an economic incentive, most typically a margin adjustment.  As outlined in the Sustainability-Linked Loan Principles, the borrower’s performance will be evaluated at least annually on a series of predetermined ESG metrics or KPIs. If the borrower meets the predetermined sustainability performance target (SPTs), the borrower enjoys a discount in the loan pricing (and vice versa).  As detailed in the Principles and its accompanying guidance document, the critical aspect in structuring a sustainability linked loan is that the KPIs selected are material and core to the borrower’s business and the SPTs are sufficiently ambitious. With those considerations in mind, the KPIs selected can be environmental, social or governance related. Deutsche Bank Research recently released a Thematic ESG report looking at trends in sustainability linked loans and bonds. Environmental targets dominate loans’ KPIs and governance-related KPIs were the least common; within environmentally-focused loans, decarbonization and renewable energy are top of mind. As this structure continues to gain traction, it is expected that those KPIs diversify further.

With the excitement that surrounds any novelty, maintaining the integrity of the sustainability-linked loan structure is paramount. The Principles offer clear guidance in that regard. The Principles now call for external verification of the borrower’s performance against the relevant KPIs over the life of the loan. With the increased focus on verification, the loan trade associations are finalizing a guidance document on external reviews to offer further direction.