Sustainable finance seems to be everywhere, dominating conference agendas and European policy making. Every day there is apparently a new “sustainable” fund launch. GlobalCapital has had a sustainable finance news service for years, but now even our competitors are belatedly launching them.
Yet the market grapples with the same fundamental problems that have bedevilled it since it launched. Investors want to avoid being punished for doing good by accepting lower returns, while issuers cannot see why they should invest in the infrastructure for an ESG issue if cheaper funding doesn’t follow.
Green bonds are, generally, priced a little tighter, or attract greater demand, than conventional equivalents — but it’s fiendishly hard to correct this tendency for the size of an issue, given that ESG prints are almost always smaller, at first, than a brown benchmark. And rarely does a company succeed in converting its whole capital structure to sustainability-linked debt.
The loan market, meanwhile, has been more explicit about the costs and benefits of sustainability — plenty of companies have now raised loans with margin ratchets related to sustainability performance. Again, though, it’s hard to see the real economic benefit.
Most of the issuers raising these loans will never draw them, and providing revolvers to IG corporates was never an entirely economic transaction — it’s the price banks pay for joining a banking group, where they might win more worthwhile bond, hedging or M&A business. What’s the harm in pricing an uneconomic, unused product even less economically?
The leveraged finance market, though, is different.
Companies, or their private equity owners, need the money, tend to raise term loans and often have less incentive to court public praise (the clue is in the “private” part). Investors in industries such as gambling, oil exploration, chemicals or metals have already accepted a certain compromise in the purity of their social responsibility claims.
Some companies, such as spyware firm NSO Capital, are sufficient to make hardnosed leveraged credit PMs choke on their cornflakes, and funds increasingly screen for the most egregious ESG offenders. Some CLOs, such as those from Permira and Fair Oaks, have this screening built into their portfolio terms.
Leveraged corporates or sponsor-backed companies also tend to group their financings according to security packages and seniority, rather than allowing for a carved out portion for ESG branding. Instead of having a green curve, brown curve and hybrid debt, they’ll have bonds and loans secured on different operating groups, plus holding company debt, second lien or other products with differing credit standards.
Sub-investment grade companies that have opted for labelled ESG debt tend to be “pure play” issuers. European Energy, a Danish renewable power firm, printed a green-certified Nordic high yield issue earlier this month, while Bayport, a microfinance company, issued a social bond. In both cases, the companies were already most of the way there — they just needed a stamp of approval from a second opinion provider.
It’s also much harder for investors to raise money for pure ESG funds focused on leveraged credit. There’s too little to buy, making any portfolios excessively concentrated. Perhaps IG-focused ESG funds can be tempted to take a walk on the wild side and buy green bonds from the better-rated HY firms, but there’s no core of leveraged demand with an ESG focus.
In loans, there’s only been one tentative step towards ESG — MasMovil’s recent refinancing. Even then, it was only the bank-provided revolver that featured a variable margin — the term loan 'B' was ESG-free, syndicated and placed as normal.
At least one private equity firm, GlobalCapital understands, has been asking banks for financing terms on a full green term loan 'B' — but privately, underwriters and leveraged syndicate bankers see little chance of this taking off.
That’s because it means confronting, head on, the really difficult problems of sustainable finance — who pays for it. Cutting margins on a loan that won’t ever be drawn is one thing, but asking banks to underwrite at tighter spreads — or give up some of their flex — is a far bigger challenge. Hard-nosed credit committees won’t want to be stuck with loans they cannot shift as the price of proving their ethical credentials.
By the same token, though, if the ESG trend ever does gather pace in leveraged finance, it will be a different animal to sustainable finance in investment grade — and far more consequential, since it will imply tangible financial benefits that go far beyond good public relations.
Sustainable finance for companies still buying and building means far more than for an investment grade firm looking to refinance. Getting there will be tough but bring on sustainable levfin.