An ESG Loans insights report

Responsible Capital: An ESG Loans insights report

Responsible Capital An ESG Loans insight report Introduction The market for green loans, sustainability-linked loans (SLLs) and social loans (collectively, ESG 1 Loans) is growing rapidly. However, it is moving so quickly that it can be hard to get a grip on market trends. We have developed an online platform which helps provide a more complete, and data-driven, picture of the market. Early in 2022, we started gathering and structuring key data on the ESG Loans our EMEA offices have advised on. We worked with our innovation programme (known as NRF Transform) to develop an online platform to collect, store and analyse the data. We are now ready to share our first insights based on the data we have gathered in over 50 ESG Loans across Europe, the Middle East and Asia-Pacific. We plan to provide further and more in-depth insights as our data set grows. Contacts Nick Merritt Partner Tel +65 6309 5318 [email protected] David Milligan Partner Tel +44 20 7444 2675 [email protected] 1 The term specifically refers to financing transactions that adhere to the principles set by the key 02 loan associations under their Sustainability-linked Loans, Green Loans and Social Loans principles.

Responsible Capital An ESG Loans insight report Chart 1 Chart 2 Industry sectors Types of margin adjustments on SLLs Shipping 8 Financial investors 1 11 Technology 3 Asset and wealth Reduction 3 management 19 Both 7 Life science and 18 Increase 4 pharmaceuticals Commodities 4 6 4 Infrastructure 22+14+12+8+8+8+6+6+16+F 50+47+3+F Power and utilities Other As a large law firm, we work in a wide variety of sectors. The Sustainability-Linked Loan Principles (SLLPs) As we would expect, given the ubiquity of ESG and provide that a key characteristic of an SLL is that an sustainability in recent years, we are seeing ESG Loans “economic outcome” is linked to whether the relevant across all industry sectors. sustainability targets are met. The SLLPs do not specify It is notable that shipping and financial investors are the what that “economic outcome” should be. In practice, most common sectors in our data set. Clients in both of in the vast majority of cases, that outcome is an these sectors have embraced the opportunity to borrow adjustment to the Margin. ESG Loans to show their sustainability credentials and to In the early days of SLLs, we generally saw downward- decarbonise their businesses. For both sectors, the vast only Margin adjustments. This made SLLs popular with majority of these ESG Loans were SLLs. This makes borrowers because there was no risk of a price increase, sense given the fact that SLLs do not have a “use of regardless of their sustainability performance. However, proceeds” requirement, so are more readily accessible in the last year or so, we are increasingly seeing lenders than green loans. insist on Margin increases for bad performance along with Based on our data, we have seen lower number of ESG Margin decreases for good performance (known as two- Loans from resource-intensive industries (commodities, way Margin adjustments). While this is not required by the power and utilities and oil and gas), but we expect that to SLLPs, lenders are using two-way Margin adjustments in increase as transition plans for companies in these sectors an effort to bolster the integrity of SLLs as a whole. develop. Our data set shows a fairly even split between “downward- Green loans in particular are being utilised in the only” and two-way Margin adjustments*. As our data set renewables sector and SLLs and social loans are of grows, we hope to track changes in Margin treatment in interest to those in the commodities sector, particularly for SLLs over time. We expect to see more two-way Margin supporting low income farmers and producers in improving adjustments in future. crop yields (which is one SLL we have worked on). * The “increase only” ESG Loan included in Chart 2 was due to the particular circumstances of that loan. Essentially, the transaction was structured so that the Margin would not be adjusted if the sustainability targets were met, but would increase if they were not met. 03

Responsible Capital An ESG Loans insight report Chart 3 Chart 5 Type of margin adjustments by region Type of margin adjustments in Asia-Pacific 1 Type of margin adjustment 7 in Europe Increase 17 Type of margin adjustment Reduction in Asia-Pacific 11 Both 7 2 17 1 4+69+27+F Increase Reduction Both Chart 4 Our data shows a significant regional difference between Type of margin adjustments in Europe the types of Margin adjustment in Europe compared to Asia-Pacific. In Europe, a two-way Margin adjustment seems to have become the standard for SLLs, whereas a one-way downward Margin adjustment seems to be the 2 norm in Asia-Pacific. Increase As mentioned previously, the SLLPs do not require a Reduction two-way Margin adjustment. However, based on our data Both set it appears that lenders in Europe have been quicker to take a harder line on this issue than their counterparts in Asia-Pacific. 11 0+16+84+F We expect that two-way Margin adjustments will become standard in Asia-Pacific soon, and there are indications that the market is starting to move that way already. As our data set grows, we hope to track these breakdowns by region and sector more deeply to provide further insights. 04

Responsible Capital An ESG Loans insight report Chart 6 The overall story from our data is that Margin adjustments Spread of margin adjustments on SLLs are generally very small in SLLs – typically a few basis points (1 basis point being 0.01%). % 0.150 However, one feature we did not expect to see is that there 0.100 is generally a wider spread of Margin adjustments for two- way Margin adjustments compared to SLLs with downward- 0.050 only Margin adjustments. It is not immediately clear why this 0.000 should be the case, but perhaps lenders are willing to allow for a greater downside (i.e. decrease of loan margin), if they –0.050 also get the benefit of a upside (i.e. increase in loan margin). –0.100 It is worth noting that increases in Margins in SLLs (for –0.150 poor sustainability performance) can cause a conundrum for lenders. Whilst receiving a higher rate of interest would Decrease (downward-only Margin adjustment) normally be welcomed by a lender, for reputational reasons, Decrease (two-way Margin adjustment) a lender may not want to be seen to be profiting as a result Increase (two-way Margin adjustment) of poor sustainability performance of a borrower. So what Average should happen to the increased interest? We have sometimes seen documentation which addresses this issue by providing that Margin increases are to be set aside and donated to charity. On its face, this is an elegant solution. However, in practice it can cause lenders further difficulties, as it then puts the onus on lenders to ensure that (a) the charity in question is doing good work and (b) the funds are actually being deployed in the intended manner. Other solutions to this problem include having the borrower set the extra money aside and apply it for an agreed green/ sustainable project (which may or may not relate to the sustainability performance targets in the ESG Loan). This adds an administrative burden to the lenders in monitoring use. In other cases, lenders will simply accept the extra interest. We will continue to monitor how this issue is dealt with as the ESG Loan market matures. 05

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