Banks Struggle to Value Good Behavior

(Bloomberg) -- Banks are long accustomed to varying loan prices based on a company’s financial strength. Now, they are working out how to price deals factoring in emissions, food waste or female hiring levels.

This shift is critical in the $110 billion sustainability-linked loan market as borrowers get discounts for achieving environmental, social and governance goals. The difficulty is that all companies face different ESG challenges -- even in the same industry -- and loan incentives are useless if targets are too vague, impossible to measure, unrealistic or too easy.

The industry has adopted two main approaches to pricing ESG loans, using either third-party companywide ESG ratings or setting specific targets, such as cutting emissions. This split is likely to continue as 30 lenders surveyed by Bloomberg News this week were evenly divided when asked which pricing method they favored.

“There is no one-size-fits all,” said Alexis Collonge, sustainable finance coordinator for capital markets EMEA, BNP Paribas SA.

Banks Struggle to Value Good Behavior

ESG Ratings

Borrowers with loans tied to ESG ratings usually get a margin discount for improving their grade. German utility EON SE, for instance, recently signed a 3.5 billion-euro ($3.9 billion) deal tied to ESG ratings at ISS, MSCI Inc. and Sustainalytics.

The main advantage of a grade is that it covers a wide range of factors, such as pollution, labor rights and anti-corruption efforts, which encourages widespread improvements across a company. Grades are also straightforward to monitor because getting a better mark clearly means improvement.

Still, ratings mask a maze of complexity, as providers distill down potentially hundreds of data points to reach a single score. Differences in weighting can greatly affect the grade, making it tricky to compare ESG ratings from different providers, particularly given the variety of scoring systems. The wide scope also makes it very difficult for larger borrowers to improve their scores as there are so many things to do.

“For top players, the ESG rating offers less upside in terms of potential improvement,” said Emilio Lopez Fernandez, head of corporate lending Iberia at Banco Bilbao Vizcaya Argentaria SA.

ESG Targets

The alternative to ratings is linking loans to a few key performance indicators, or KPIs. For instance, French agricultural cooperative Agrial signed a 900 million-euro loan tied to five specific goals including worker safety and the development of organic products.

Using KPIs avoids much of the complexity found in ratings, as lenders and borrowers can clearly see what is being assessed and how. It also helps borrowers focus on key areas, often cutting emissions.

“KPIs can set concrete targets for companies to achieve and be a powerful internal lever to drive change,” Collogne said.

The difficulty is setting a target that is ambitious without being impossible. KPIs’ narrow scope also means companies can get ESG-loan bonuses for improvements in areas covered by pricing targets, even if performance deteriorates elsewhere.

©2019 Bloomberg L.P.

BQ Install

Bloomberg Quint

Add BloombergQuint App to Home screen.