How Companies Get Cheaper Loans for Doing Social Good

(Bloomberg) -- Virtue can bring material rewards, as more companies are discovering when they reach out for a loan. Some banks have started to give borrowers discounts if they meet targets for doing good things, such as cutting pollution, reducing food waste or even assisting job seekers. To give the incentives teeth, there are penalties for missing goals. Global issuance of loans linked to environmental, social and governance (ESG) performance surged almost seven-fold last year to $36.4 billion, riding a wave of global demand for financing options that let companies promote themselves as socially responsible. This new sort of borrowing has different names, including positive incentive loans, ESG-linked or sustainability-linked.

1. How do the loans work?

No matter what they’re called, the deals are set up like normal term loans or revolving credit facilities, often with a group of banks providing a pool of funds for the borrower. Traditional loans are priced versus a benchmark rate used in lending between banks, such as the London Interbank Offered Rate or Libor. The borrower pays an additional premium, or spread, on top of this, which is based on factors such as credit ratings and deal length. An ESG-linked loan has an extra twist, a spread discount or penalty that depends on the borrower’s success in meeting specific targets.

2. What sort of target?

The targets can be quite varied, as long as both sides agree on the goals. Belgian plastics maker Solvay SA got a 2 billion-euro ($2.2 billion) facility with pricing tied to reductions in greenhouse gases. An Electricite de France SA deal included emissions goals, along with targets for adopting electric vehicles in its own fleet and boosting customers’ use of online tools for monitoring energy consumption. Irish foodmaker Greencore Group Plc tied a loan to factors including reducing food waste and landfill use, while U.K. housing association London & Quadrant had a goal of helping 600 residents find jobs each year. Another approach is for a borrower to achieve a specific score from a company that independently assesses ESG standards. Borrowers get graded on factors such as sourcing materials in a way that respects the environment, use of electric vehicles and efforts to promote women in the workplace.

3. How big is the ESG incentive?

It’s hard to make any generalizations. The market is still quite new and borrowers don’t always reveal the full details of their loans. Still, it’s possible to get an idea from what has been made public. U.K. education company Pearson Plc can potentially save as much as $1.5 million per year on a $1.2 billion revolving facility because of an ESG incentive of 1.25 basis points. A basis point is a hundredth of 1 percent. SBM Offshore NV, a Dutch oil-services provider, negotiated a 5 basis-point incentive on a $1 billion loan linked to reductions in its carbon footprint. That’s a potential cost-saving -- or penalty -- of about $5 million per year. Companies can also save even if they don’t use the funds available in a credit facility because lower spreads usually lead to lower bank fees for undrawn commitments.

4. What’s in it for lenders?

The main advantage for banks may be customer loyalty. Many ESG-indexed loans have been negotiated as replacements for older facilities nearing maturity, meaning borrowers could have shopped around for a deal elsewhere. The loans may also help lower banks’ financing costs because companies with strong ESG policies tend to have good track records for profitability and debt repayment. Furthermore, regulators and policy makers are pushing banks to pay more attention to the environmental and social impact of transactions. That’s led to more than 90 banks, investment managers and insurers worldwide adopting responsible banking principles developed with the United Nations. Europe has led the way in this area, helping make it the biggest region by far for ESG-linked loans. Local lenders also have more room to offer incentives than U.S. banks due to higher fees on undrawn commitments. European banks including Banco Santander SA, BNP Paribas SA and ING Groep NV dominate ESG-loan arranging, based on data compiled by Bloomberg.

5. What challenges does the sustainable loan market face?

As with other efforts to link environmental and social goals to financing, such as green bonds, a big challenge for ESG-linked loans is ensuring that deals truly have a positive impact -- and proving it. To try to prevent the sector becoming just a marketing tool for lenders and borrowers, the three main global loan associations have drawn up a framework for the deals. The main criteria are for borrowers to be transparent in their overall corporate social responsibility strategy; to set targets that are more ambitious than what they have already achieved; and for their actions to be evaluated by unbiased, independent assessors. Even then, there’s a lack of agreement on how to objectively gauge a company’s social responsibility. The European Union is also working on standards for the sustainable investing sector. The different ESG challenges faced by different industries may also hold back standardization, which could inhibit market growth.

6. How do the loans fit in the wider ESG finance market?

There’s a plethora of green and socially responsible financing options out there, and the variety keeps expanding. Green bonds are the largest part of the sustainable finance market at more than $176 billion in 2018, according to BloombergNEF. Still, growth in the more-than-decade-old market slowed to just 1.7 percent last year. ESG-linked loans were the fastest growing part of the whole ESG finance sector in 2018, albeit from a much smaller starting point. Major differences between the two products include how the money can be used and the pricing. Green-bond funds must be spent on projects that are designed to be environmentally friendly. Pricing is also fixed at sale, with no potential discounts or penalties. Sustainable loans can offer much more flexibility because there is no requirement to use the funds solely for investments directly tied to meeting the ESG goal. Any pricing incentive is purely based on whether the borrower hits or misses the target, without worrying about how.

The Reference Shelf

• Global loan associations’ Sustainability Linked Loan Principles and Green Loan Principles.
• BloombergNEF on how sustainability-linked loans benefit from loan industry guidelines.
• BNEF’s 2019 sustainable finance outlook.
• An EU Technical Expert Group’s work on developing standardized disclosures for sustainability performance.
• Chart showing growth of sustainable debt worldwide.
• Bloomberg article on the potential size and challenges of sustainable loans.
• Bloomberg article on the growth of ESG loans in Asia.
• Functions for the Market article about using Bloomberg’s ESGHub

To contact the reporter on this story: Jacqueline Poh in London at jpoh39@bloomberg.net

To contact the editors responsible for this story: Hannah Benjamin at hbenjamin1@bloomberg.net, Neil Denslow, Melissa Pozsgay

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