Having arrived fashionably late to the debt capital markets green finance ball, the tough kids of leveraged finance are now flinging themselves into every rumba and Argentine tango they can.
Not only are sober environmental, social and governance purists a little alarmed at their antics but the levfin revellers themselves are riven with doubt about whether the shapes they are throwing are strictly up to scratch.
Sustainability-linked loans free borrowers from all the constraints of use of proceeds-based green debt, of having to allocate proceeds to specific green or social purposes. Instead, a company can set sustainability targets of its own choosing, and get a pricing benefit from lenders if it meets it.
This arrangement can hardly harm anyone, and only risks greenwashing at one remove, if such loans are aggregated into portfolios that are then presented to third parties as green.
But participants are still anxious to ensure that their structures are robust and credible. No one wants to be called out as a green cheat or social hypocrite. The central issue is the sustainability performance targets (SPTs) to which loans are tied. Who is to decide what is ambitious, satisfactory or shoddy?
The issue is particularly tricky for private credit funds, which make their own loans, without banks’ help. Lacking the broad deal making experience of banks, across many asset classes, they are having to make it up as they go along, creating what some would call a fount of innovation, others a haphazard mêlée.
They should take a deep breath, have a sit down and read the guidance of the market elders — the Sustainability-Linked Loan Principles and Sustainability-Linked Bond Principles. Granted, this won’t take them long — the advice is brief and high level.
But both documents steer borrowers to use targets that can be “benchmarked, i.e. as much as possible using an external reference or definitions to facilitate the assessment of the SPT’s level of ambition.”
This means using accepted standards, ideally those designed to address environmental and social improvement. A central example is Science-Based Targets, the system that enables companies to obtain independent validation that they are decarbonising fast enough to give the world a chance of avoiding catastrophic climate change.
Objective standards exist for specific sectors too, such as real estate or shipping, which enable a company to be compared against peers. Marching ahead of competitors, in the view of independent observers inclined to be critical, is the best way to demonstrate true ESG zeal.
When levfin lenders learn to keep it simple, not try to impress with too many fancy targets, and go for comparability, the market will gain the clarity it seeks.