Yesterday I attended the LMA and LSTA conference which this year was fantastically forward-looking, with sessions including 10-year outlooks and what to watch in this bumper year of elections. This provided some much-needed food for thought in these uncertain times. My interest was piqued by the sustainable finance session which posed the question 'investible or a cost of doing business'. The panel took stock of the market whilst highlighting the potential areas of expansion.
The conference also coincidentally fell on the same day the chancellor announced the Spring budget, but there turned out to be few surprises and consequences as for the UK's sustainable finance market.
I've set out my key takeaways from the sustainable finance session below:
1. SLL volumes and transaction dynamics
The sustainability linked loan (SLL) market has retained its resilience, as the issuance of SLLs relative to non-SLLs remained broadly the same year-on-year. This reflects a continued desire from lenders and borrowers for these loans, as both feel increasing pressure to engage with each other on sustainability issues and solidify their ESG commitments within their financing arrangements and portfolios.
However notable hurdles which can affect the cost/benefit analysis of SLLs for borrowers still persist.
SLL reporting standards and sustainable disclosure requirements have both matured and become more complex as the market and technology develops. Consequently, the reporting undertakings can be much more onerous than even a few years ago and the related reputational and compliance risks higher. Whilst this trajectory of more stringent standards is generally welcomed by the market, it does increase the burden on borrowers.
Borrowers are re-assessing what the perceived benefit of an SLL is: aside from good corporate citizenship, the debate regarding the relative benefit of the margin ratchet continues and is particularly pertinent in investment grade deals where a facility may remain undrawn.
2. Documentation and 'sleeping' SLLs
KPI selection and SPT setting are the backbone of SLL transactions and often the most debated aspect of any SLL transaction, particularly surrounding the previously intangible but ever more mandated Scope 3 greenhouse gas emissions. The establishment of systems to collect, record and report such data (if not already done so) cannot be established quickly, and faced with transactional timing pressure this can preclude a borrower's access to SLLs.
Discussed was a potential solution to facilitate reporting on Scope 3 emissions under an SLL whilst maintaining execution deadlines: the obligation to report would develop alongside a borrower's reporting ability, including partial reporting with a future obligation to update the relevant SPT as its technical capacity improves. Clearly to maintain integrity, there would need to be sufficiently strict guidelines about how to use such a 'grower' KPI (other material and complete KPIs simultaneously used, requirement to retire/amend KPI by a certain deadline), but still an interesting example of innovation in this space.
In a similar theme of granting borrowers time to get to grips with what may be new requirements, sleeping SLLs have been on the uptick. Whilst this shows greater confidence in the mechanism, lenders are requiring the SLL drafting is all settled at origination save for the actual KPI and SPT data points to be slotted in later. This, alongside the requirement to convert into an SLL by a certain deadline, continue to provide parties with the necessary greenwashing protection.
3. Fiduciary duty and management
Notwithstanding reflection on ESG issues being recognised as part of fiduciary duty, there continues to be a call for more consideration of sustainability in practice. In particular, for legislative development of the duty under a framework for pensions fund management, particularly to "empower trustees to take real action to consider social and environmental impacts alongside risk and return".
In terms of fund management, the effects of greenhushing can be felt as some issuers may downplay their commitments, possibly concerned over accusations around any ESG backlash. Despite this, there has been some convergence around the view investment decisions should be affected by sustainability factors and with such considerations varying between industries and sectors. As different funds assess and price their identified negative externalities, a variety of investment strategies and product designs will likely emerge with no 'one size fits all'. Funds will also need to take into account that not all sustainability journeys or processes will progress on a straight-line basis.
4. Transition and 'pure play' companies
Transition finance has previously received an unwarranted bad rep as the market was ill-defined and without a clear pathway or purpose. Since then, much work has been put into identifying the various components and financing needs for the green economy transition alongside installing secure guardrails around such labelled transactions. As part of this reconciliation, in the US particularly, pure-play companies (entities which derive their revenue from green activities) have emerged as the key players in economy-wide transitions. Think of companies providing maintenance and support for clean energy generation.
Even with a limited contribution from the Spring Budget, we should expect some developments and growth in transition financings following realisation of the scale of change needed and the opportunity at hand.
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