The idea of environmental, social and governance (ESG) didn’t even enter the common vernacular until around 2018. This new concept is already heavily under fire from some conservative or right-wing political actors.
However, even with the definition being fluid, some banks are integrating ESG into financial instruments and credit policies. Financial institutions making ESG-linked loans evaluate loan applicants on relevant factors such as climate risk and renewable energy, diversity and workplace health and safety, and leadership transparency and accountability. Renewable energy is clearly becoming a key priority for lenders. With sustainable finance gaining traction as a powerful tool to effect change, industries like solar will see increasing opportunities for growth.
Green finance
Against a backdrop of rising energy prices, the Russian-Ukraine conflict, the ongoing pandemic, and a worsening climate crisis, the UP Initiative focuses on green finance. How can this sector help address these issues and what needs to be done to achieve positive progress? Discover more hereI’ve been a banker in the ESG space for many years and seen it grow firsthand. According to data from Bloomberg Intelligence, the total value of ESG investments is projected to exceed $53 trillion by 2025, representing more than a third of all global investments. Additionally, professional services provider PwC reported the sustainable finance market reached $1.6 trillion globally in 2021 and approximately $600 billion of that was driven by a growing sustainability-linked loan (SLL) market.
SLLs are defined as “any types of loan instruments and/or contingent facilities (such as bonding lines, guarantee lines or letters of credit) which incentivize the borrower’s achievement of ambitious, predetermined sustainability performance objectives.”
Consumer attitudes are also fueling the growth of sustainable finance. A study by Global Risk Regulator found that an overwhelming majority of respondents expected sustainable financial services to become the norm (93%) – and almost half expect this to be the case by 2025. I’ve also seen the demand for our eco-focused products increase. A few years ago, I would never have imagined ESG financing would come to the forefront of public conscious like it has.
Impacts of the shift
In response to consumer attitudes and the growing climate crisis, banks are moving away from fossil fuel industries and toward renewable energy industries like solar. This effort is accelerated by efforts like the Net-Zero Banking Alliance (NZBA), an industry-led, UN-convened alliance of banks worldwide, representing about 40% of global banking assets, which is committed to aligning lending and investment portfolios with net-zero emissions by 2050.
To support the UN’s Sustainable Development Goals of affordable and clean energy, sustainable cities and communities, climate action and partnerships, many banks are developing specialized residential and commercial loan products designed to encourage the use of solar energy. These loan products include loans for rooftop solar systems, loans for energy efficiency improvements, sustainably certified commercial real estate financing, and sustainably certified construction loans.
While ESG loans and SLL loans in particular can fuel more opportunities for the solar industry, many borrowers need more clarity on the requirements for securing this type of loan. As banks prioritize ESG loans, the credit policies and environmental risk assessment associated with these loans are still being developed.
However, there are guidelines to SLL and ESG-targeted lending that can help borrowers navigate the loan process. Sustainability-Linked Loan Principles (SLLP), developed by representatives from leading financial institutions, provide voluntary recommended guidelines that can be applied by market participants on a deal-by-deal basis.
Sustainability targets
A part of the SLLPs is the assessment of the project to which a loan may be made in terms of Sustainability Performance Targets (SPTs). SPTs should represent a material improvement in the respective KPIs and be beyond a “Business as Usual” trajectory. They should be comparable to a benchmark or an external reference, and be consistent with the borrower’s overall sustainability/ESG strategy. Importantly, they should be determined on a predefined timeline, set before or concurrently with the origination of the loan.
A key characteristic of an ESG loan is that an economic outcome is linked to whether the selected predefined SPTs are met. For example, failure to achieve specific targets can result in an increase in the loan’s interest rate by a pre-determined number of basis points. On the flip side, success in achieving targets can reduce the loan interest rate.
The SLLP recommends that borrowers provide their lenders an annual report including up-to-date information to allow lenders to monitor the performance of the SPTs and to determine that the SPTs remain ambitious and relevant to the borrower’s business. Borrowers are also encouraged to provide details of any underlying methodology of SPT calculations and/or assumptions when reporting to lenders.
Under the SLLP, borrowers are required to obtain independent and external verification of their performance level against each SPT for each KPI. An auditor, environmental consultant and/or independent ratings agency should perform this verification at least once a year.
Global energy investment is set to increase by 8% this year, reaching $2.4 trillion, with the anticipated rise coming mainly in clean energy, according to a new report by the International Energy Agency. ESG loans are a big part of that picture. As solar companies become more familiar with and successful in navigating the ESG loan process, the result will be industry growth, job creation, increased solar deployment and greater awareness of climate-positive energy for years to come.
Sustainability-Linked Loan Principles
An SLL should include:
- Selection of Key Performance Indicators (KPIs)
Mission-aligned loans, aimed at improving the borrower’s sustainability profile over the term of the loan, align loan terms to the borrower’s performance. This performance is measured using one or more sustainability KPIs that can be external and/or internal.
KPIs should be:
- Relevant, core and material to the borrower’s overall business, and of high strategic significance to the borrower’s current and/or future operations
- Measurable or quantifiable on a consistent methodological basis
- Able to be benchmarked
- Calibration of Sustainability Performance Targets (SPTs)
Calibration of SPTs for each KPI is an important part of structuring values-based loans, as these performance targets represent the level of ambition to which the borrower is ready to commit.
About the author
Ken LaRoe is a leader in the field of ethical banking. Three years after the sale of his first bank, Florida Choice Bank, LaRoe was able to put this approach into action with the founding of First GREEN Bank. Under LaRoe’s leadership, First GREEN Bank expanded across Florida and his values-based business model demonstrated that financial excellence can occur without ethical compromise. LaRoe sold First GREEN Bank in 2018. He then founded the Climate First Bank, founded on the premise that a bank can actually contribute to the drawdown of atmospheric CO2.
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