Improvement the next chapter in sustainability

ING is the pioneer of the sustainability performance-linked loan (SPL) globally. Leonie Schreve, Amsterdam-based global head of sustainable finance, and Herry Cho, Singapore-based head of sustainable finance, Asia Pacific at ING, give KangaNews the lowdown on the nascent asset class.

A good place to start is on the relative evolution of green loans and SPLs. How big are the markets relative to each other and what is the potential for each?

SCHREVE Green loans have a longer history but have not tended to be structured to finance specific projects. The improvement-linked loan is an ING-designed concept and we were first to put this type of loan into the global market. We have issued more than 40 transactions and we have acted as sustainability coordinator on more than half of these. The uptake of these loans globally has been significant.

The initial interest came from firms which already score very highly in sustainability aspects, such as Koninklijke Phillips. However, greater demand now comes from companies that view themselves as being in a challenged sector but for which sustainability issues are important. This type of company is eager to make a firm commitment around sustainability.

Engagement is increasing not so much because a potentially lower margin is one of the advantages of the SPL product but because it demonstrates a serious commitment to change. It is a simple but powerful concept for a company to meet its sustainability ambitions and these are not easy targets to reach as we set the bar high. The upside is potentially a discount on the margin, but on the other hand clients are willing to pay a penalty if their sustainability performance falls.

CHO As well as executing the first loan of this type out of Europe, ING issued the first SPL in Asia. This was a bilateral loan between ING and Wilmar International. ING also arranged and acted as sustainability coordinator on the first syndicated SPL loan, in the form of a US$500 million club deal for Olam International.

There is considerable interest in SPL product in Asia, in part because it is focused on transition and improvement. It really does not matter where a company is as a starting point, provided there is a demonstrable, material improvement in overall environmental, social and governance (ESG) direction.

The Loan Market Association (LMA) has launched a new set of loan principles: the sustainability-linked-loan principles (SLLPs). These, like the green-loan principles (GLPs), seek to set specific parameters around the governance and rigour of the instruments. They include information on how to select sustainability criteria, how to measure improvement through third-party involvement and how to give some indications of timeframe.

The GLPs set a standard for companies to follow and supported the execution of several key transactions from the Asian region, for example the first green loan for Macquarie Bank. We expect a similar pick-up in activity after the SLLPs come into effect.

To what extent did the GLP form the basis for the SLLP?

CHO It was a very collaborative process and the GLP and SLLP committees are identical. However, by their inherent natures the two products are quite different. One is a use-of-proceeds loan while the other focuses on improvement settings. This difference, even in the type of third-party review that is required, is being considered in the final version of the SLLPs.

"The SPL product is around 18 months old and of the transactions we have closed around half our clients have met their targets. This indicates that the targets we have set are robust and ambitious."
LEONIE SCHREVE

Given what you are describing is largely a transition product, are there any particular industry sectors that the product best lends itself to?

SCHREVE An SPL can extend towards companies which are not solely active in green activities. It can help companies in the agriculture, telecoms or energy sectors that are seeking to future-proof their businesses by transitioning to green or social. It can also help companies with insufficient assets to bring a 100 per cent green or social transaction.

I believe the SLLPs will support greater uptake across sectors. From a regulatory perspective, conversations are ongoing around the requirement to introduce preferential status in respect of green finance. It is important to our clients that they can show the steps they are taking to improve in this area – whether via a green loan or a product like an SPL where they can demonstrate environmental transition.

CHO Most of the more than 40 transactions issued globally to date have ESG ratings as their base. These ratings take some sectoral considerations into account but they predominantly rely on broader ESG factors. In this sense, the product can apply to any sector.

However, it is also possible to be more detail-oriented around the ESG drivers for a particular sector and, even if a company is unrated, KPIs can be used as a benchmark to drive change.

What is the weighting of the ‘E’, ‘S’ and ‘G’ in SPLs?

SCHREVE It depends on the rating agency but in principle each factor has a relatively equal weighting. However, when the benchmark is against KPIs it is not a given that all three areas will be included. Even so it is imperative that the score reflects a high ambition to improve within the overall sustainability approach.

CHO It is important to mention that unlisted companies are not able to cherry-pick what may be more favourable for a KPI. There is a clear difference between what is material and within the control of the company and what is material and outside its control. The type of change we are trying to incentivise is to act on what is within the company’s control.

"We set targets based on rigorous conversations about a company’s overall sustainability as well as its scores. These ensure an understanding that this is neither a stretched target nor an opportunity for cheap funding without an incentive to achieve a set goal."

How challenging are the targets borrowers have to achieve as performance hurdles in SPLs?

SCHREVE The SPL product is around 18 months old and of the transactions we have closed around half of our clients have met their targets. This indicates that the targets we have set are robust and ambitious. We have seen an uptake in different structures and in more banks becoming active in the product but we believe it is very important that standards remain high. This is another reason the LMA’s SLLPs are important.

CHO We set targets based on rigorous conversations about a company’s overall sustainability as well as its scores. These are held with the sustainability officer with the treasury team present, which ensures an understanding that this is neither a stretched target nor an opportunity for cheap funding without an incentive to achieve a set goal.

SCHREVE The same applies to unlisted firms with KPI targets. We provide specialised knowledge through a team of experts around the globe that work closely with the sustainability lead at a client organisation to define ambitious but achievable KPIs.

What sort of incremental pricing can SPL borrowers receive?

CHO We have seen a pricing benefit of 5-10 per cent of the base margin.

SCHREVE But I should say again that the key driver is definitely not a reduced pricing outcome – it is an ambition to transition in sustainability.

Presumably there is a quantitative aspect to SPLs. What is the evidence linking sustainability and financial performance?

SCHREVE In designing the SPL we researched how to indicate the health of a business from a sustainability and a credit perspective by looking at our own portfolio. We put sustainability ratings next to credit ratings in the listed part of our portfolio and we found that, on average, companies have a better credit rating if they have a high sustainability rating.

Of course, the question is whether this comes down to a higher sustainability effort or the fact that these companies are just better managed.

To me, this is an indicator that companies are taking their licence to operate seriously by future-proofing their businesses. This means it is an important indicator but not necessarily a sign of being a ‘good’ credit.

CHO History is no longer an indication of future performance. We are helping our clients become future-ready. This is a forward-looking exercise, but it is not remote – and is already very much front of mind for some companies in the Asia- Pacific region with a greater business focus on fossil fuels.

Are SPLs exclusively going to be a bank product?

SCHREVE There is not enough supply to meet the demand of the number of investors that are transitioning their mandates towards green strategies, so investors will need to look for other means to allocate their green investments. This could well be to green-loan product as well as to a compound pool of SPLs.