Ethical Lending Sweeps Into Europe’s Leveraged Loan Market

Lenders to sub-investment grade companies in Europe are seeing a surge in the number of loans where the interest rate is linked to sustainability targets.

Deals worth more than 25 billion euros ($29.9 billion) that came to market this year will pay less if the borrower hits environmental, social and governance goals -- or more if they miss. That’s an eight-fold jump from less than 3 billion euros for the whole of last year, data compiled by Bloomberg show.

Investors and owners are increasingly putting pressure on fund managers, banks, private equity sponsors and borrowers to demonstrate that they are allied with the broad societal shift toward greater social responsibility. Some skeptics, however, want to see more ambitious targets and greater transparency.

Ethical Lending Sweeps Into Europe’s Leveraged Loan Market

ESG targets, known as KPIs or key performance indicators, range from carbon emissions, recycling and women in managerial roles, to customer satisfaction and employees’ work-life balance. Companies that achieve their KPIs can typically save up to about 10 basis points off the margin.

“A company that improves its sustainability performance by reaching KPIs lowers the risk of a lender’s portfolio so it only makes sense to offer incentive to the interest rate,” said Ana Carolina Oliveira, New York-based Head of Sustainable Finance at ING Americas.

Some investors are skeptical about loans linked to ESG goals and want to see companies set ambitious targets that are monitored by third parties. They’re also concerned about whether privately-owned firms are disclosing enough information for lenders to get a clear view of performance.

“Maybe it’s even more important for higher leveraged companies to disclose their ESG data,” said Oliveira, noting that sustainability-linked deals need additional reporting.

Even though the trend for this deal structure is new in Europe, it’s already being applied across many sectors. This week, lenders are reviewing loans for chemicals firm Nobian Finance BV, flooring maker Tarkett SA and food retailer Prosol SAS.

In the bond market, junk-rated issuers only started selling sustainability-linked notes this year, with 3.4 billion euros of sales so far.

Embedding Sustainability

Borrowers are also keen to signal their ESG intentions even if their plans aren’t fully baked. Virgin Media Ireland raised a loan this month that included a June 30, 2022 target date for announcing its ESG strategy, and a December 31, 2021 date for setting a greenhouse gas emissions target.

“There is the possibility of a little bit of greenwashing, but as this loan structure requires borrowers to monitor their ESG performance, it still helps to embed sustainability into company operations and management,” said Nneka Chike-Obi, Director, Sustainable Finance, Fitch Ratings.

©2021 Bloomberg L.P.

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