The trend for green and sustainability-linked financing that has captured western Europe is filtering into emerging markets.
Borrowers in central and eastern Europe, the Middle East and Africa are attracted by benefits including racking up brownie points with lenders, priding themselves on helping to fight climate change and sometimes even lowering their cost of funding.
In the past two years, international trade associations have codified green and sustainability-linked loans to boost and regulate issuance. Green borrowers must use the loan for a specific green purpose and report on this. Sustainability-linked loans are for general corporate purposes, but the interest margin can be varied, depending on how the borrower performs on certain ESG metrics.
Sustainalytics, the provider of ESG ratings and corporate governance research, rates 11,000 firms, of which 460 are in CEEMEA. Companies can apply to it to license their rating, enabling them to use it for marketing securities or structuring sustainability-linked loans. If Sustainalytics does not already rate the firm, it will make a new rating. In 2019, up to mid-November, 12 companies in CEEMEA asked Sustainalytics for this licence.
“More EM borrowers are requesting to be rated by ESG agencies, which shows a desire to monitor their capabilities,” says Sandrine Enguehard, head of positive impact structuring at Société Générale in Paris. “But borrowers aren’t defining their CSR strategies and getting rated just to do green loans, but because there is a growing pressure to be sustainable and environmentally responsible.”
In 2019, a handful of sustainability-linked loans were signed in EM, notably a $300m facility for Ghana’s Cocobod, a $2bn revolver for the United Arab Emirates’ Noor Energy, both in March, and a $1.1bn loan for Russia’s Rusal in October. But these and the other deals are a mere sprinkling, compared with the 87 green and sustainability-linked loans signed in Europe by mid-November.
Though these specialist loans are still a fraction of EM debt, lenders are confident that green and sustainability-linked loans will multiply in CEEMEA in future. But there are many parts of the ESG puzzle that EM borrowers must fit together first.
Rocky road
The difficulties are numerous. “The delayed uptick in the number of borrowers raising ESG-linked loans is down to awareness and education,” says Anna-Marie Slot, global sustainability partner at law firm Ashurst, in London and Hong Kong. “A key challenge for many borrowers is actually understanding fundamental structural features of the product, such as what it means to enter into an ESG-linked facility, how they can track key performance indicators internally and how much more work is created for treasury teams.”
Arranging a green or sustainability-linked loan is not just a case of asking relationship banks for a cut in margins. With a green loan, the borrower must have specific green assets and set up a process for selecting them. Sustainability-linked loans can be simpler, as there is no asset tracking. But lenders are wary of deals put together too hastily.
Usually, a loan’s margin is linked to company performance, either on an ESG rating from an external provider, or on key performance indicators (KPIs) that the firm defines itself.
If it is an external rating, the company needs to obtain or license this, and both it and lenders must be comfortable with what the firm can do to improve its rating, and what could cause a deterioration.
Internally defined KPIs should ideally grow out of a sustainability strategy that the board is pursuing. That will mean the company is working on sustainability initiatives, to which the indicators can be tied.
“This is a long term strategy — implementing corporate social responsibility policies is not something a corporate can do in a few months. It is a long term process they may be engaged in for years,” says Enguehard.
To make the deal signify a real commitment to sustainability, KPIs ought to be both stretching and relevant to the company’s core business.
Such deals are fairly easy for companies whose senior management has been engaged with sustainability for years, and which already have programmes for implementing improvements. But many in CEEMEA have not done this yet.
Nevertheless, there are bright spots. Companies in the Middle East have shown a particular interest in green capital markets. In the UAE, property company Majid Al Futtaim issued a $600m green sukuk in May, and ports group DP World set up a Sustainable Development Financing Framework to prepare for issuance.
After the 2015 Paris Agreement, Gulf states announced programmes to decrease oil dependency and boost renewable energy production, which lenders predict will create big opportunities for ESG-linked financing.
“The conditions are favourable for ESG-linked issuance [in the Gulf], especially in the UAE, where there are a large amount of renewable energy projects under way and a number of large borrowers with clear sustainability objectives. This is definitely a market where we will see more growth,” says William Sharpe, managing director, corporate loan syndicate at Natixis in Paris.
In March, a $2.5bn green loan was raised to support Noor Energy 1 in Dubai, set to be the world’s largest concentrated solar power plant.
In 2018, DP World obtained a $2bn sustainability-linked revolving credit facility and Masdar a $75m green revolver for clean technology and sustainable real estate.
“In the Middle East, until recently, only entities focused on renewable energy were considering green financing, but now more corporates have developed broader ESG policies and are able to pursue sustainability-linked financing,” says Rizwan Shaikh, co-head of loan syndication EMEA at Citigroup in London.
But developing a framework is only part of the jigsaw. Once the loan is signed, borrowers will have to become transparent, providing reports on green assets and processes.
“There are many constraints borrowers face, such as extra cost and specific reporting requirements,” says Sharpe. “Plus doing a green loan invites significant scrutiny that would not have been the case otherwise.”
EM companies, many unlisted, tend to do less public reporting. “Most emerging market companies are not familiar with ESG,” says Ian Howard, director of sustainable finance solutions at Sustainalytics in Toronto. “There is a large education process that borrowers go through, and that is especially longer for first movers in their regions.”
But making the first move may not be so hard. “The assumption is that it is too much work or too difficult but we’ve found that is not the case,” says Slot at Ashurst. “Companies already track a lot of data on financial and performance metrics — they need to assess what KPIs are workable and what they are able to accurately assess on an ongoing basis.”
It’s not about the money
Despite the difficulties, more EM borrowers are attracted to ESG-related financing. And the main draw is not cost, as one might think.
The price discount borrowers can obtain is minimal. Cocobod’s $300m three year sustainability-linked loan in March had an initial margin of 295bp over Libor. That will tighten by 15bp if Cocobod meets ESG metrics. For some EM borrowers, that tightening may appeal; but for most, there are wider benefits.
“The pricing discount under sustainability-linked loans is moderate,” says Sharpe. “Many borrowers do sustainability-linked loans to project a positive image internationally in terms of their ESG credentials.”
With green bonds, a company can attract investors that would not otherwise buy its debt. But this is harder to be sure of in the loan market, where loans are usually given on a relationship basis.
But, Slot says: “A common complaint is that the pricing differential is not beneficial enough, but doing an ESG-linked loan buys a company a whole new set of investors.”
Some borrowers have a particular reason to want the extra green sheen a sustainable loan can give them. When Rusal, the Russian aluminium company, came to the market in October for a $750m sustainability-linked pre-export financing (PXF), it was its first entry into international debt markets since the US had lifted sanctions against it in January.
The deal was a great success, and was increased to $1.085bn. “It was not just the green format that was driving the demand, but rather Rusal’s long track record in the application of green technologies, production of low carbon aluminium and focus on sustainability in general,” says Oleg Mukhamedshin, head of strategy and financial markets at Rusal in Moscow. “The demand was high because the market sees and supports Rusal’s commitment to low carbon aluminium technologies and green aluminium production.”
Perhaps surprisingly, Western banks have been busy arranging sustainability-linked loans in Russia. ING signed bilateral sustainability-linked credit lines with firms such as Polymetal and Metalloinvest in the past two years.
“Sustainable finance seems to be a quickly developing trend,” says Mukhamedshin. “We want to ensure that we are in the forefront of the current trends, and with sustainability-linked PXF setting the bar, we might consider other types of sustainable financing instruments.”
Several Russian firms are obtaining ESG ratings. “The pick-up in activity in ESG-related loans has been driven by investors, as large Russian corporates are facing more questions about what they’re doing in the sustainability space,” says Vladislav Chiriac, head of CEEMEA loan syndicate at UniCredit in London. “We will definitely see more green or ESG-linked loans in Russia in the next two years.”
But the onus is not only on borrowers. If banks want the market to grow, they too must encourage green financing, even if it costs them. “To stimulate issuance, banks can continue to steer their internal lending policies towards more environmentally friendly borrowers,” says Sharpe.
Natixis introduced a green weighting factor to its internal capital model in 2019. Others are set to emulate it.
If EM borrowers overcome hurdles to green financing, a much bigger share of their debt can involve sustainability criteria.
Slot at Ashurst says: “We will see a definite growth in green and sustainability-linked loans in EM, as banks become more cognisant about the scope of the global crisis.” GC