Environmental and social governance (ESG) is here to stay as a permanent fixture in many public and private business plans. Additionally, sustainable lending is now a growing component of ESG practices and business strategies. To ignore ESG in the business planning process is considered short-sighted as ESG criteria are now firmly embedded as a component of focus with numerous institutional investors and are playing an increasing role in corporate finance and lending.
Sustainable lending has been gaining traction lately and will likely accelerate dramatically over the next decade. The ramifications of sustainable investments and lending are significant for businesses. Shareholder ESG satisfaction investment criteria are currently partially correlated to interest in a company’s stock. The criteria around sustainable lending may also influence and reduce the overall cost of debt for a company enhancing profitability with the additional benefit of improving reputational risk.
Historically CEOs have held the belief that investment returns are the key to a company’s overall success. Now it appears that while investment returns are still key and top of mind for management, corporate responsibility in the form of sound ESG practices is also a measuring stick of success.
So, what is driving the interest in sustainable lending? Many feel it is due to personal and corporate social awakening. The current interest in sustainable lending is driven by both the investors and the companies themselves, anxious to improve upon their ESG reputation among existing and potential stakeholders.
Reputation management is a primary concern of all companies in today’s internet-based world of instant attention; hence companies are mindful to put their best foot forward with respect to social responsibility. Public opinion can easily steer the directional success of companies, so ESG is now on the mind of most progressive boards.
Why so? Suppose the public or even an individual perceives a business is behaving unjustly or was lacking in social responsibility? In the blink of an eye, a simple internet post that garners attention and spreads negative sentiment can potentially affect sales and influence a drop in stock price.
So how has lending entered into the realm of ESG? In the past, green projects and green loans contributed to building a positive image for both a borrower and a lender. Green loans still do help create a positive image, however, now the ESG tide has recognized that more than giving or receiving a green loan moves the dial with respect to ESG.
ESG starts in the board room and it relates in part to taking internal and external actions to improve the environmental sustainability of their companies’ operations and activities. So where does sustainable lending fit into the equation? Today various lenders will tie ESG incentives into loan agreements that can effectively reward the borrow with lower rates if they can show the adoption of sustainable practices and adherence to ESG practices. This is happening on both a corporate, country, and investment level basis.
So how does a sustainable loan differ from a green loan? Sustainability-linked loans generally differ from other green-related financings in that their usage and borrowing rates might differ. Hence, this type of lending might be more attractive to the borrower, as the use of loan proceeds is less restrictive, and the interest rate can ratch down based on adhering to ESG practices contained within the borrowing agreement. For instance, unlike green loans and bonds, sustainability-linked loans could be employed for everyday corporate purposes instead of just funding projects that might reap environmental rewards. On the other hand, bond financing is often tied to a fixed interest rate, but sustainable lending rates may not be, and ESG incentives exist that could lower borrowing costs. Typically, sustainable lending drives significantly broader corporate performance when compared against ESG criteria.
Some of the driving factors behind ESG loans extended to corporations and countries might for instance address human rights and labor conditions, political contributions, climate change, sustainability, and ESG policies such as diversity and gender pay gap in work settings.
Sustainable lending from both a lender’s and borrower’s perspective demonstrates a business’s commitment to environmental concerns, giving them green credentials from a growing pool of investors that favor sustainable practices. As ESG and sustainability continue to gain traction in board rooms and with investors, expect more investor scorecards to incorporate the criteria.
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