Time for tougher scrutiny of sustainability-linked lending

Target-based lending must be used effectively in Asia’s sustainable transition

Sustainability-linked loans are catching on quickly as a transition financing tool across Asia Pacific. In the region, SLL issuance leapt to nearly $60bn in 2022 from around $33bn in 2021, according to data from Moody’s Investors Service and Environmental Finance, with Chinese technology giant Ant Group converting a syndicated credit facility into a $6.5bn SLL last year. This is the largest of its kind regionally and third biggest globally.

This type of funding is necessary for a region that emits more carbon than any other. Unlike green loans – which must only fund projects making a substantial contribution to an environmental objective and are off-limits to many Asian companies that have yet to move away from their carbon-intensive business models – SLLs are available to borrowers in any sector. They provide flexible, all-purpose funding and are less restrictive than financings tied to a specific use of proceeds.

SLLs work because the interest margin shifts up or down in line with the borrower’s performance against pre-set key performance indicators. The borrower typically pays a lower margin if it hits its KPIs, which might include a specified amount of emissions reduction or a higher margin if it misses them. The format, therefore, helps to encourage borrowers to contribute to sustainability from an environmental, social and governance perspective.

Greenwashing, however, presents a real threat to the growth of the SLL market. Investors and others have voiced worries that the targets are often not credible – they are too easy to achieve or not aligned with a borrower’s core business. If those practices become commonplace, the financial incentives will quickly become meaningless and lenders will lose their ability to effect change.

The Asia Pacific Loan Market Association, together with the Loan Market Association and Loan Syndications and Trading Association, has laid out clear criteria for what qualifies a loan as green, social or sustainability-linked.

A core recommendation is to use an independent external review to validate the KPIs and sustainability targets. There is, however, no consistent standard around the quality or content of these opinions. Greater transparency in this area would be of huge help to our members and the wider financial sector in the battle against greenwashing. Guidance on external reviews are regularly updated to ensure standards remain robust.

This work aligns with efforts in the UK and the European Union to hold providers of ESG ratings to account for their services, with a view to ensuring improved transparency and good conduct in the public capital markets.

In a similar vein, a clear set of rules and standards for external reviews would give the financial community the confidence to scale up sustainability-linked lending. As more listed companies in Asia turn to SLLs to help accelerate their transition, exchanges and other market supervisors have a responsibility to ensure that disclosures are fair and accurate.

Regulators should be prepared to call out misconduct in the SLL market and hold external reviewers, lenders or borrowers to account. Even in privately negotiated syndicated loans, borrowers should be encouraged to disclose sustainability targets if they are to enjoy the reputational benefit of an SLL.

SLLs hold enormous potential as a tool for change in Asia. As the market grows and lenders compete for sustainable assets, these debt instruments are bound to attract intense scrutiny. It is in everyone’s interest to make sure they are not found wanting, as the energy transition needs all the financial help it can get.

Andrew Ferguson is Chief Executive Officer and Juliana Shek is In House Counsel at Asia Pacific Loan Market Association.

This article is part of the Sustainable Policy Institute’s Summer 2023 journal launching 11 July.

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