The faltering horse of sustainability-linked finance received welcome refreshment last week from Crédit Agricole CIB, in the unlikely shape of a ¥3bn privately placed bond.
The bank has become the third, after Bank of China and Nordea, to issue a bond whose proceeds are allocated, in the manner of a green bond, to a portfolio of sustainability-linked loans.
This event could prove a turning point for the SLL market, which — despite huge issuance since it was invented in 2017 — has recently been taking a pasting in the court of public opinion.
As GlobalCapital has reported in numerous articles, a product that loan bankers once hailed as the most exciting, hope-inspiring light in their market is now more likely to induce yawns and shrugs ― or worse, embarrassed shudders.
So many news articles have criticised the product, and it has been so weakly defended, that in a time when banks and companies are terrified of being accused of greenwashing, some of them are quietly backing away from SLLs.
The heart of the problem is the accusation that the key performance indicators (KPIs) and sustainability performance targets (SPTs) attached to these loans are too weak. Companies can earn a loan margin reduction for too little improvement in sustainability, critics allege. The margin variation ― which can be upward for backsliding on sustainability as well as downward ― is anyway too small to matter, they say.
Putting it on paper
Against this background, CA CIB’s inaugural ¥3bn ‘sustainability-linked loan financing bond’ or SLLB, worth just €17.5m, is not itself a source of sustenance for the SLL market.
Nor is the programme of deals the investment bank intends to issue. As with most green bond issues, the main purpose of issuing SLLBs is communication and marketing, rather than anything very concrete or financially decisive.
The tonic Crédit Agricole has brought to the market is the Sustainability-Linked Loan Financing Bond Framework it has crafted to underlie the programme.
As GlobalCapital reported on Monday, CA CIB has set out a detailed set of criteria that define which sustainability-linked loans can be included in the portfolio backing its new fleet of SLLBs, and which cannot.
Every loan must give the borrower a key performance indicator to reduce greenhouse gas emissions, falling into one of seven types that Crédit Agricole has defined and described.
The rules ensure the KPI covers a sufficient share of the company’s emissions, and that it is ambitious enough to be aligned with an emissions reduction trajectory that, if replicated worldwide, would allow the world to limit climate change to 1.5°C or well below 2°C. There are a few exceptions, but this is the basic standard, and alignment should be validated by the Science-Based Targets Initiative or an “equivalent” third party.
Loans can have other KPIs too — but only from a menu of 16 categories, ranging from ‘Diversity and Inclusion’ to ‘New Generation Aircraft’, for which CA CIB has set conditions.
The need to write an explicit framework for its SLLBs has compelled CA CIB to organise and codify its thinking on what constitutes a robust SLL, accumulated over seven years of structuring and investing in the loans.
To the great benefit of the market, Crédit Agricole has decided to apply a fairly rigorous standard, and to publish the criteria.
By putting this on paper in explicit terms, CA CIB has crystallised the debate on whether SLLs are rigorous from a conversation about generalities into one with some actual facts to discuss.
Existing standards
This is not the first attempt to set detailed, sector by sector standards for sustainability-linked finance and corporate transitions. The Science-Based Targets Initiative itself is one; the Transition Pathway Initiative another.
In April 2023 the Climate Bonds Initiative launched a certification scheme for companies in transition and their sustainability-linked debt. Companies must have “ambitious and credible performance targets, a delivery strategy and implementation plan”, the CBI told GlobalCapital at the time, to apply (and pay) for certification either as aligned with 1.5°C or in a ‘certified transition’ to become aligned by 2030.
CA CIB’s scheme is not as comprehensive or fine-tuned as these, and in many places it relies on whether companies’ targets are aligned with these older systems.
Down and dirty
What CA CIB’s intervention offers, that the NGO ventures do not, is that it comes from a bank, with a real business underwriting and structuring loans, and wide contact with companies in the commercial arena.
According to Dealogic, CA CIB has been a bookrunner on €527bn of SLLs for 273 companies in the past four years, ranging from tiny deals to huge ones for the likes of Ford, Siemens Energy, Enel, Airbus and Alphabet. That was 30% of the whole market by volume, and a sixth of the borrowers.
Most SLLs are revolving credit facilities that are never intended to be drawn. Only drawn parts of loans can be used to back an SLLB, so the new market will only ever be a small fraction of the size of the SLL market.
Agricole has not said how large its portfolio of SLLs is, nor what the drawn balance is. All it has revealed is that the portfolio eligible to back SLLBs is €1.4bn at the moment.
We don’t know what proportion so far of Agricole’s SLLs have made the grade. But the bank did tell GlobalCapital that it would put all its SLLs, drawn or undrawn, through the filter to qualify for the SLLB portfolio.
What this means is that the Framework represents, as a CA CIB banker put it, “best market practice” — and in the view of one of the top five bookrunners of such loans.
The SLLB criteria are meant to set a high standard ― but it clearly must also be a realistic standard, that a major bank thinks it is sensible and practical to apply, and which a decent number of its SLLs will meet.
The new Framework has implicitly already been road-tested on a real, and large, portfolio of loans.
For the sustainability-linked loan market this is huge.
For years bankers have said “we have high standards and make sure the loans where we are the sustainability structuring adviser have relevant KPIs and ambitious SPTs”. What they never did was explain what those standards are, or give any evidence on which to judge their claims of probity.
Crédit Agricole ― and Nordea, too, which also deserves credit as the forerunner that set out its criteria for SLLBs, though less explicitly than CA CIB ― have now started that conversation.
Hiding its light
In an opinion article in February, GlobalCapital set out ‘How sustainability-linked loans went wrong’.
The product itself was a useful idea, we argued, but had been poorly implemented.
The market’s original sin is opacity. Companies issue SLLs ― whose main purpose is communicating their devotion to sustainability targets ― but refuse to reveal what those targets are. They also keep secret how much the margin variation is.
Why? The sustainability targets can only be part of general corporate policy, which the company can only pursue if its stakeholders agree. The margin variation is trivial and usually a market standard, having no commercial sensitivity.
Making these loans opaque is not only a total waste of their communicative power, but actually damaging because it attracts suspicion.
In the poor reputation it now suffers, the market is reaping the bitter harvest of its coyness.
Crédit Agricole’s set of criteria is a welcome first step to making sustainability-linked loans a grown-up, well governed market.
Its Framework is not perfect, as the bank was the first to admit. Plenty of the criteria are still defined in general terms and leave wide discretion in how CA CIB can interpret them. That is only to be expected ― real life situations are complicated and full of unexpected issues.
But this is a really good starting point. Other banks must now get involved and continue the work.
On we go
Here are two directions in which the market should move towards a more convincing and relevant future:
1. Real transparency. Create a new standard of ‘Transparent SLL’ in which the borrower discloses all KPIs and SPTs, reports on progress, and reveals the margin variation structure and whether it is used. All of this is taken as read in the sustainability-linked bond market. Banks like Crédit Agricole should include only Transparent SLLs in their SLLB portfolios, and should name the borrowers and amounts allocated to them.
2. Informed but civilised debate on transition standards. Banks should publish their criteria — not just for the ‘best practice’ SLLs, as Crédit Agricole has done, but the minimum they will accept. These standards will differ. Some banks will be more lenient on some issues than others. Fine. That is the market reality already — there is no need to shame the more generous ones. But this step would let a burst of daylight into this market, moving the debate from futile gossiping over a drink after conferences to an open, rational discussion and negotiation.
Virtually no company is sustainable right now. Sustainability-linked finance is debt that prompts the right conversation — how is this company going to transition to a sustainable future?
If market players set out on these two paths, the SLL market will quickly be rejuvenated and once again become one of the most dynamic zones of corporate finance. With luck and hard work, it could even start to influence the pace of transition.