The flow of finance is all encompassing. It determines longevity, success or failure for many businesses. So What does green lending have to offer?
Any conversation on the burgeoning role of green lending in 2022 starts with a strong definition of the terms and the theory.
For this, we need look no further than the World Bank, which is the largest development finance institution supporting the private sector in emerging markets and the leading provider of green loans among international development banks.
The Bank explains that a green loan is a form of financing that enables borrowers to use the proceeds to exclusively fund projects that make a substantial contribution to an environmental objective.
This is a somewhat lawyerly description, but basically it means green loans are exclusively to be used for environmental means. The Bank goes on to look at some of the minutiae.
A green loan, it says, is similar to a green bond, in that it raises capital for green eligible projects. But a green loan is based on a loan that is typically smaller than a bond and done in a private operation.
A green bond usually has a bigger volume, may have higher transaction costs, and could be listed on an exchange or privately placed. Green loans and green bonds also follow different but consistent principles: The Green Loan Principles and the Green Bond Principles (GBP) of the International Capital Market Association (ICMA). Both instruments specify that 100% of the proceeds should be used only for green eligible activities.
Perhaps most crucially, the Bank then lays out the criteria for what a green loan actually is in the real world, which are well worth repeating in their entirety:
What makes a loan a green loan?
To be called a green loan, a loan should be structured in alignment with the Green Loan Principles, which provide an international standard based on the following four core components:
- Use of Proceeds: Designated Green Projects should provide clear environmental benefits, which will be assessed, measured, and reported by the borrower.
- Process for Project Evaluation and Selection: The borrower of a green loan should clearly communicate how it is organised to assess and select projects that will receive loan proceeds. In addition, the borrower explains how it will manage environmental and social risk of eligible projects.
- Management of Proceeds: The proceeds of a green loan should be credited to a dedicated account or tracked by the borrower to maintain transparency and promote the integrity of the product.
- Reporting: The principles recommend the use of qualitative performance indicators and, where feasible, quantitative performance measures (for example, energy capacity, electricity generation, greenhouse gas emissions reduced/avoided, etc.)
With these details covered, the next question within our analysis surrounds how such lending can set business sailing on a more sustainable path.
The sustainable options opened by greener lending
First off, let’s be in no doubt surrounding the scale of what’s happening. The Financial Times reports that renewables and other climate friendly ventures received more bank issued bonds and loans than the fossil fuel sector for the first time in 2021.
It also notes that further backing is in the pipeline. Deutsche Bank, JP Morgan Chase and HSBC are among over a dozen banks whose annual green financing commitments outstrip their 2020 support for fossil fuels. The sense is other banks are following suit and these metrics on the direction of their lends are likely to lean further towards the sustainability mark.
So, the truth for 2022 appears to be this, there has never been a more apt moment to seek financing for a sustainably-driven, categorically environmental business concept.
It needn’t be a brand-new business or concept either. Green lending is equally applicable to both expansion from green companies and realignment to a greener agenda from firms who need to transition off previously unsustainable activities or balance sheets.
But, don’t think it’s easy…
Market forces though remain in place. Where a product or loan type is becoming more widely available, expect the usual heightened competition for the new green money and deeper evidencing on the transparency of the environmental commitments set against the cash.
The Financial Times implicitly notes this, commenting that definitions of green finance have at times been ‘generous’. This sense is changing fast, driven by the likes of the Net Zero Banking Alliance.
This membership organisation, of which Deutsche Bank is a part, requires the calculation and modelling of the carbon footprint of members’ loans portfolios worth billions of euros.
This simply can’t happen; unless the organisations pumping out the greener finance rapidly and continually tighten and manage their assessment criteria to ensure all lending flowing out the door is truly contributing to a greener agenda.
The summary therefore is that there’s never been a better time to access greener cash to deliver profitable objectives set against both capital, environmental and financial criteria.
After all, no one ever said that environmental aims need contradict profit aims. In fact increasingly, there’s a strong realisation that environmentally benign business offers profit in a more rationalised, longer term context than the short-termist, exploitative business concepts which largely drove industrialisation glancing down the years.
A word on opportunities within the UK
On these shores, beyond the major banks and financial institutions, there is a desire within government to get greener lending moving faster. Today’s UK government promises show ambition to make the UK the best place in the world for green and sustainable investment.
Coincidentally, that ought to make the UK the best place in the world to leverage such investment for corporate and environmental benefit too.
Since launching in September 2021, the government’s green financing programme has raised more than £16 billion from the sale of Green Gilts and NS&I’s Green Savings Bonds. These funds support projects with clearly defined environmental benefits.
There are six types of green expenditures that are financed by the Green Gilt and retail Green Savings Bonds. They include clean transportation, renewable energy, energy efficiency, pollution prevention and control, living and natural resources and climate change adaptation.
Further, published in October last year, the government has created a guide: ‘Greening Finance:
A Roadmap to Sustainable Investing’.
Self-evidently, this is well worth a read from any corporate considering applying for green finance, or indeed any new business launches seeking guidance on how to tick and manage the many assessment criteria.
Among some of these criteria are the need that UK investment products, financial services firms and corporates will be required to report consistent information on sustainability.
In addition, green loans will need to hit the following metrics:
- Streamlined – the regime will streamline existing disclosure requirements – such as the UK’s commitment to make reporting aligned with the Task Force on Climate-Related Financial Disclosures (TCFD) mandatory – with new requirements, including on reporting environmental impact.
- Consumer-focused – investment products will need to set out consumer-focused disclosures showing the impact, risks and opportunities of the activities they finance on sustainability. This will be accompanied by a consumer-facing label developed by the FCA so that consumers can make informed investment decisions that take sustainability into account.
- Credible – asset managers, asset owners and investment products will be required to substantiate sustainability claims they make.
- Robust – disclosure requirements will include reporting under the UK Green Taxonomy, which will provide a robust list of economic activities that count as environmentally sustainable.
- In line with international standards – the UK is a strong advocate for international standards for sustainability reporting, and is preparing the ground to adopt international standards in this area (subject to consultation).
The US view
Of course, key to the success of green finance is the response of the world’s biggest economy, the USA. Here, sustainability-linked loans are up 292 percent on 2020 figures, with growth in both investment-grade and high-yield markets. Increasingly, US companies are converting their borrowings to sustainability-linked loans, an asset class which Bloomberg referred to as ‘taking off’.
The value of US loans with terms tied to environmental, social and governance targets is now estimated to have increased to about $52 billion, in a trend which began before the coronavirus pandemic as investor picked up on sustainable themes. Among the firms seen to be linking revolving credit facilities to targets including carbon emissions, renewable energy and workplace equality are Cisco Systems Inc., BlackRock Inc. and General Mills Inc.
Speaking to Bloomberg, Marilyn Ceci, global head of ESG debt capital at JP Morgan Chase, said: “The sustainability-linked revolving credit facility is being very warmly received and accepted by corporate issuers in the U.S…We see nothing but demand increasing for the product.”
These debt instruments are distinct from green financing, where proceeds are restricted to purely environmental aims. Instead green loans have no such limits, and can be linked to key performance indicators such sustainability goals or ESG ratings from companies such as Sustainalytics and EcoVadis. For instance, manufacturing services firm Jabil Inc. has a revolving credit facility with an arrangement for it to get up to four basis interest points cut or increased depending on whether it achieves goals set for it in greenhouse gas emissions, health and safety.
The final word
Above all, it is essential that both new green financiers and new green borrowers play by the rules. The government’s guide defines ‘greenwashing’ as when misleading or unsubstantiated claims about environmental performance are made by businesses or investment funds about their products or activities.
This, it says, can lead to the wrong products being bought – undermining trust in the market and
leading to misallocation of capital intended for sustainable investments. Greenwashing was the most frequently cited concern amongst respondents to the 2021 Schroders Institutional Investor Study, with 60 percent of investors raising it as a challenge. The green money is there. The opportunity is rich. For both business and planetary purpose, this mustn’t be undermined by lies.