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Sustainability Linked Loans

If you are transforming your business to a sustainable organisation by defining an ambitious sustainability strategy and/or by improving your external sustainability rating, Sustainability Linked Loans are worth investigating. Sustainability-linked loans incentivise companies’ sustainability performance by linking the interest margin to the improvement of the companies’ ESG score or to the improvement on tailored sustainability KPIs.

EBA (European Banking Authorities) – Guidelines


The EBA defined the following principles concerning ESG:  

4.3.5 Environmental, social and governance factors (ESG)

56. Institutions should incorporate ESG factors and associated risks in their credit risk appetite and risk management policies, credit risk policies and procedures, adopting a holistic approach.

57. Institutions should take into account the risks associated with ESG factors on the financial conditions of borrowers, and in particular the potential impact of environmental factors and climate change, in their credit risk appetite, policies and procedures. The risks of climate change for the financial performance of borrowers can primarily materialise as physical risks, such as risks to the borrower that arise from the physical effects of climate change, including liability risks for contributing to climate change, or transition risks, e.g. risks to the borrower that arise from the transition to a low-carbon and climate-resilient economy. In addition, other risks can occur, such as changes in market and consumer preferences and legal risks that may affect the performance of underlying assets.

4.3.6 Environmentally sustainable lending

58. Institutions that originate or plan to originate environmentally sustainable credit facilities should develop, as part of their credit risk policies and procedures, specific details of their environmentally sustainable lending policies and procedures, covering the granting and monitoring of such credit facilities. These policies and procedures should, in particular:

a. Provide a list of the projects and activities, as well as the criteria, that the institution considers eligible for environmentally sustainable lending or a reference to relevant existing standards on environmentally sustainable lending that define what type of lending is considered to be environmentally sustainable;.

b. Specify the process by which the institutions evaluating that the proceeds of the environmentally sustainable credit facilities they have originated are used for environmentally sustainable activities. In cases of lending to enterprises, the process should include:

  1. collecting information about the climate-related and environmental or otherwise sustainable business objectives of the borrowers;
  2. assessing the conformity of the borrowers’ funding projects with the qualifying environmentally sustainable projects or activities and related criteria;
  3. ensuring that the borrowers have the willingness and capacity to appropriately monitor and report the allocation of the proceeds towards the environmentally sustainable projects or activities;
  4. monitoring, on a regular basis, that the proceeds are allocated properly (which may consist of requesting that borrowers provide updated information on the use of the proceeds until the relevant credit facility is repaid).

126. Institutions should assess the borrower’s exposure to ESG factors, in particular environmental factors and the impact on climate change, and the appropriateness of the mitigating strategies, as set out by the borrower. This analysis should be performed on a borrower basis; however, when relevant, institutions may also consider performing this analysis on a portfolio basis.

127. In order to identify borrowers that are exposed, directly or indirectly, to increased risk associated with ESG factors, institutions should consider using heat maps that highlight, for example, climate-related and environmental risks of individual economic (sub-)sectors in a chart or on a scaling system. For loans or borrowers associated with a higher ESG risk, a more intensive analysis of the actual business model of the borrower is required, including a review of current and projected greenhouse gas emissions, the market environment, supervisory ESG requirements for the companies under consideration and the likely impacts of ESG regulation on the borrower’s financial position.

Example: VERBUND has placed their first ESG (Environmental Social Governance) linked syndicated loan of EUR 500 million with 12 banks. VERBUND signed a syndicated loan in the amount of EUR 500 million and a term of 5 yearss. The interest rate during the term of the loan is determined once a year and exclusively on the basis of the results of an external sustainability rating.

ISDA on Sustainability-Linked Derivatives

Several Sustainability-linked derivatives have been issued over the past years: such as IRS (Interest Rate Swaps), cross-currency swaps or forwards. These transactions are customizable and use various ESG-related KPIs (key performance indicators) to define sustainability goals. In general, it is set-up the way that if you achieve pre-agreed sustainability ESG-target(s), your margin would be reduced, providing a financial incentive for improved ESG performance.

Example:

Italo – Nuovo Trasporto Viaggiatori, a private rail operator: As part of the loan transaction, the company also executed a sustainability-linked interest rate swap (IRS) that included an incentive mechanism aligned with the sustainable performance indicators outlined in the financing agreement.

Next Steps

In addition to an ESG rating-linked sustainability loan, your company can also choose to link its margin to specific sustainability-related performance indicators. The financing instruments should be closely linked to your sustainability strategy and follow your ESG roadmap. Contact us to set-up your first sustainability linked loan or ESG interest rate swaps.

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Georg Tichy

Georg Tichy

Georg Tichy is a management consultant in Europe, focusing on top-management consultancy, projectmanagement, corporate reporting and fundingsupport. Dr. Georg Tichy is also trainer, lecturer at university and advisor on current economic issues. Contact me or Book a MeetingView Author posts