By Océane Balbinot-Viale and Armand Satchian, ESG Analysts, Crédit Mutuel Asset Management Crédit Mutuel Asset Management is an asset management company of Groupe La Française, the holding company of the asset management business line of Credit Mutuel Alliance Fédérale
A declining sustainability-linked financing instruments market bolstered by the resilience of Sustainability-Linked Loans (SLLs)
In 2021, the International Capital Market Association (ICMA) launched the Sustainability-Linked Bond Principles (SLBP) which provide guidelines for linking the financial characteristics of bonds to the achievement of ESG-related objectives. Simultaneously, the European Central Bank (ECB) started to accept SLBs as collateral for its asset purchase program.
That same year, SLB issuance reached a peak of $97 billion (9.0% of total 2021 labelled bond issuances), highlighting companies’ participation in the labelled fixed income market regardless of the size of their pre-identified green and/or social asset pool. However, since then, we have observed a decline in the popularity of the instrument, with just $66 billion in issuance in 2023 (6.7% of total labelled bond issuances) . In parallel, despite a decline in volume (-34% YoY at H1 24 standing at $275 billion), the SLL market proves to be robust and, since 2019, represents the bulk of labelled loans (c. 75% of total labelled loan market in H1 24).
Despite a slowing volume over the past year due mainly to higher interest rates and perceived reputational risks, SLLs have proven more resilient than SLBs for multiple reasons.
The long-standing imperative for the decarbonization of loan portfolios is arguably a key driver of sustainability-linked debt market growth in the banking sector. The initial push came from the regulatory side in 2020, with the ECB requiring banks to incorporate climate-related risks into risk management and stress testing frameworks . The Bank of England, through its Prudential Regulation Authority, also placed significant regulatory pressure on banks when, in 2019, it issued its Supervisory Statement which set out expectations for them to develop robust plans to address climate-related financial risk.
While a recent ECB study indicates that eurozone banks have started to price climate risk in their lending policies , several stakeholders have observed that the integration of climate transition risk has historically focused on reporting and commitments (e.g., heatmap to classify transition risk materiality, financed emissions and associated targets) and that banks have generally struggled to thoroughly embed these risks into decision-making processes.
This is why, beyond the initial (and ongoing) regulatory push, the role of initiatives such as the UN-initiated Glasgow Financial Alliance for Net-Zero (GFANZ) and its Net-Zero Banking Alliance (NZBA) sub-group in creating a resilient SLL market should be underlined. For example, NZBA members commit to aligning their lending and investment portfolios with net zero emissions by 2050 and are also required to set targets for 2030 or sooner within 18 months of joining. In addition, members commit to disclosing annual reports, which measure progress relative to board-approved transition strategies, including climate related sectoral policies and actions.
While investors occasionally lack access to sufficiently exhaustive information on how banks concretely address climate transition risks across their lending portfolios, awareness is growing around how SLLs can contribute positively to reducing the banking sector’s exposure to climate transition risks.
Another reason why the decline of SLLs has been less pronounced than that of SLBs is because SLLs are often syndicated by a limited number of banks, with the necessary expertise and know-how.
The close borrower-lender collaboration allows for a detailed understanding of sustainable needs and objectives which inevitably facilitates loan structuring and more specifically the fixing of Key Performance Indicators (KPIs) and Sustainability Performance Targets (SPTs), which are closely aligned with the borrower’s unique sustainability strategy. The frequent interaction between the borrowers and lenders facilitates monitoring and adjustments to targets and surrounding discussions.
It also makes agreeing on the economic outcome easier (e.g., coupon adjustments or one-time payments based on whether the predefined SPTs are met). In contrast, the bond market involves a much larger and more diverse group of stakeholders, which makes such customisation and ongoing engagement more challenging. As such, the loan market can accommodate more complex and numerous KPIs, whereas the bond market tends to favor simpler ones,.
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