In recent years, financial institutions have been keen to stay ahead of the regulators and adopt a holistic approach to their own Environmental, Social and Corporate Governance (ESG) strategy to ensure they are well-placed to meet the financing and advisory needs of new and emerging sectors.
The result of this means that the market for financial products that pursue sustainability objectives has grown substantially in terms of volume and diversity. For corporates, this presents an exciting new opportunity.
One such product available is sustainability linked loans, which facilitate and promote sustainable economic activity and growth (without a specific use of proceeds requirement) by incentivising the borrower’s achievement of ambitious, predetermined ESG performance targets through the pricing of the loan. These loans can be applied to working capital facilities, term loans, revolving credit facilities, or more specialist trade finance. As well as being applied to new loans, sustainability linked targets can be integrated into existing facilities.
The use of sustainability linked products has historically been dominated by large energy companies with sustainability targets linked to emissions. However, despite the practical challenges that come with measuring wider ESG performance, a number of developments are making it easier for other corporate borrowers to benefit from the availability of these products.
Developments in assessments, analytics, economic valuation and natural capital accounting have meant that Key Performance Indicators (KPIs) have diversified to more borrower specific, non-emission focused ESG targets. This gives borrowers more flexibility to identify any areas in their businesses where ESG sustainability can be improved and link these KPIs to their financing.
As sustainability reporting becomes mandatory for large corporates, it will become easier for those required to monitor ESG for the purpose of disclosure to use those metrics for their own borrowing.
At the same time, for mid-market corporates, incorporating ESG into overall business strategy is not just about disclosure or managing risks. Regardless of whether sustainability targets have already been set or whether ESG already forms part of their overall business strategy, sustainable finance provides a unique opportunity regardless of the region, market and industry in which they operate.
There is an undeniable opportunity for corporates of all sizes to benefit from access to new capital sources from lenders that are responding to the global shift in investor sentiment. As financial institutions focus on ensuring that their lending meets their own commitment to sustainability targets, green and sustainability linked financial products are becoming increasingly more accessible.
In the short to medium term, the price of finance will continue to be based on credit risk rather than ESG credentials. In the longer term horizon, we anticipate a shift as ESG credentials contribute more and more to a company’s overall creditworthiness.
Investor sentiment, consumer demand and societal expectations impact businesses and as large corporates begin to put pressure on suppliers to be as sustainable as possible, demonstrating that your company is sustainable makes it considerably more marketable – not only to other companies but also to financial institutions looking to align their customers with their own ESG values.
It has become clear that sustainable finance will play an integral role in a sustainable and resilient post-pandemic global economic recovery: to ‘build back better’ and ‘build back greener’. The EU has said it will launch €225bn worth of green bonds as part of the €750bn borrowing that will fund its Covid-19 recovery plan. In the UK, leaders from over 150 businesses and the public sector have recently called on the Prime Minister to use the Sustainable Development Goals to create a socially just and green recovery from the Covid-19 pandemic.
While the pandemic may provide an opportunity for new sources of capital, it has also highlighted the value of resilience to disruptions in the market. Globally, companies with higher ESG ratings have outperformed others throughout the pandemic.
With these opportunities in mind, we would encourage corporates of all sizes to review their existing financing arrangements and look to align these with their ESG values and targets. In doing so, businesses will begin to see sustainable and long term economic benefits.
Written by Paul Crighton and Michael El Gawly
This article was first published by North West Business Insider
This publication is intended for general guidance and represents our understanding of the relevant law and practice as at February 2021. Specific advice should be sought for specific cases. For more information see our terms & conditions.
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