by Daniel Campbell - Banking and Finance
Undeniably difficult though this year's lockdowns have been - where most international travel and aspects of industrial production were postponed - one positive has been the impact upon the environment. In the UK, the levels of NO2 in the air fell, whilst in mainland Europe the canals of Venice ran clear, with fish populations visibly thriving.
There are fears, however, that as the world economy staggers back to life in 2021, any environmental gains made will be wiped out as businesses hurry to return to pre-Covid levels of production.
Alongside this, there has been a continued increase in consumer pressure influencing the decisions businesses are making. The power of social media means that negative press is often magnified, as evidenced by the pressure placed upon Liverpool Football Club and Tottenham Hotspur, which resulted in U-turns regarding the furloughing of staff.
For similar reasons, as attitudes continue to change, the British Government seems to be (after a long period of silence) returning environmental issues to the top of the political agenda. There have been some significant announcements about changes in agricultural policy as the country moves along its chosen route of Brexit and can take the opportunity to overhaul its agricultural policy, which has for too long rewarded industrial farming and done little to encourage farmers to make sustainable decisions which benefit the environment.
Borrowers and lenders clearly need to consider the shift in consumer attitudes further towards a "health and caring economy", and of course many do; the promotion of sustainable solutions and the production of sustainable / eco-friendly products are at the very top of the priority list for many businesses.
Sustainable Financing and Sustainability-linked Loans
The move towards sustainable financing has been rapidly accelerated by the Covid crisis and is a good opportunity for both borrowers and lenders to support environmental change, mirror consumer attitudes and drive future growth.
In July 2020, the Prime Minister pledged around £350m to help to cut carbon emissions and tackle climate change. The pledge furthers the UK Government’s June 2019 Green Finance Strategy. The strategy aims - with the support of the Government - to align private sector financial flows with clean, environmentally sustainable and resilient growth, whilst simultaneously strengthening the competitiveness of the UK financial sector.
Whilst much has been written about the rise of the Green Loan (a loan which must solely be used for an approved, green purpose), less has been written about Sustainability-linked loans.
Sustainability-linked loans are an alternative and possibly more attractive form of green financing. Unlike green loans, these loans do not need to be allocated exclusively towards a green project in the way that green loans do. Instead, sustainability-linked loans can be used for any purpose but with the Borrower committing to internal sustainability performance targets (for example, a reduction in greenhouse gas emissions or improvements in energy efficiency). Should the borrower meet these targets, the loan may attract a lower interest rate or other commercial benefits. On the other hand, should the Borrower fail to meet its targets, there is no penalty and the loan will simply continue on its contractual terms.
The benefits of this product are therefore clear. Whereas green loans tend to be of limited use only for large businesses with projects which particularly lend themselves to a green project (for example the construction of a carbon-neutral building, sustainability-linked loans can be taken advantage of by all types of business, large and small, and with project of modest or more wide-ranging implications.
Why are Sustainability-linked loans not more common?
By the end of 2019, the market for sustainability-linked loans was worth approximately $110bn, but why isn't this number higher? Are borrowers demanding enough of their lenders? Are borrowers unaware that these products are on offer? Are lenders doing enough internally to price these loans effectively?
The benefits attached to these sustainability-linked loans are threefold:
- a benefit for the borrower in that it is able to satisfy the new demands of stakeholders whilst also benefitting financially;
- a benefit for the lender in that its stakeholder demands are also satisfied and the loans can be priced accordingly, so that even the maximum reduction in interest or margin is profitable; and
- a benefit to the environment and wider population generally as both lenders and borrowers are motivated to find environmentally friendly solutions to business as usual problems.
Businesses continue to come under increasingly heavy stakeholder pressure, and continue to want to drive a sustainable agenda. As we enter a new year in which we will need to see greater stimulus into the economy, and a real need for businesses of all types to take on new financing options, 2021 may be the year for banks and government to work together to make a sustainability-linked loan a no-brainer for any business looking at its financing options.
The concept of “Green Finance” has been around for over a decade and the signing of the Paris Agreement on climate change in 2015 introduced the idea to a wider audience. However a survey commissioned by Tandem Bank has found that over half the UK population still has no idea what green finance is and how it contributes to the UK’s commitment to a zero carbon economy by 2050.