Sustainability-linked financing, where borrowers are rewarded for sustainability improvements, has been enthusiastically embraced by sectors such as energy and agribusiness. But it’s still a fledgling market where few loans have reached maturity. Jacob Atkins examines what’s next for the product and whether it can make an impact.


Oil traders, palm oil producers, rubber plantations, chemical manufacturing. It reads like a list of some of the most environmentally risky pursuits in international trade, but is also an index of industries where companies signed sustainability-linked financing deals in 2021.

Far from being sustainability outcasts, polluting firms that have the most ground to make up in an era of environmental, social and governance (ESG) financing are embracing cheaper borrowing costs in exchange for greening their operations or suppliers.

Sustainability-linked loans are generally based on a handful of key performance indicators (KPIs) tied to goals that can range from modest (making offices more energy efficient, for example) to ambitious (such as deep cuts in greenhouse gas emissions).

While structures vary, meeting those targets will generally afford the borrower a saving on their financing costs, while missing the targets will lead to steeper interest, or penalties if lower pricing has already been extended.

Most seek to comply with sustainability-linked loan principles (SLLPs) first launched by a network of global loan market associations in 2019, but don’t have to. Some base pricing on a borrower’s maintenance or improvement of an ESG rating, such as those compiled by ESG ratings organisations like MSCI, RepRisk and Sustainalytics.

Proponents of the arrangements say an oil company trimming its financing costs by reducing its direct emissions is at least a step in the right direction.

Banks are also hungry for sustainability-linked financing deals. They lose a sliver of the lending margin, but in return get to keep hold of valuable clients – or even lure new ones – while being able to boast that they are helping dirty firms clean up their act.

Experts say interest in such deals has grown rapidly during the pandemic – albeit off a low base – and it’s only a few years until most, if not the vast majority, of financing facilities for large corporates contain a sustainability element.


Green financing for oil, agri

Oil trading giant Gunvor inked its first sustainability-linked revolving credit facility (RCF), worth US$1.45bn, in November last year, following a sustainability-linked borrowing base facility signed in 2018.

Despite being a lynchpin of the global oil trade, Swiss-headquartered Gunvor will be rewarded for efforts to slash its direct greenhouse gas emissions by 40%. That only includes emissions from its own operations, not those that enter the atmosphere when the oil it buys and sells is burned.

In March last year Trafigura, one of Gunvor’s rivals in the oil trading business, for the first time structured its RCFs – to the value of US$5.5bn – as sustainability-linked loans.

Trafigura will receive sweetened debt costs if it manages to curtail its direct greenhouse gas emissions (it has a 30% reduction target over three years), grows its renewable energy portfolio and starts sourcing metals in line with ISO 20400 – an international standard for sustainable procurement. If it doesn’t meet those targets, the trader will pay more for the facility.

Under a sustainability-linked financing arrangement, a borrower can be rewarded for improvements in one area even if it engages in emissions-intensive activity elsewhere. Even while boosting renewable energy investments to the tune of US$2bn, Trafigura will take a “business as usual” approach to crude oil, the company told GTR in February 2021.

Is it incongruous for key nodes in one of the world’s dirtiest businesses to lower their financing costs for meeting sustainability targets while still facilitating large-scale emissions? Not so, says Dave Rome, strategic director at law firm Ashurst, because companies have to start somewhere, and the scope and ambition of the facilities will grow over time.

“I believe that everyone should access these facilities, it doesn’t matter what you do, you can be more sustainable,” he tells GTR. “With those who are at the brown end of the market, you are probably going to see several iterations of sustainability-linked facilities over a longer period of time, simply because they have a longer journey to take.”

A company involved in a heavy-polluting industry can also secure a relatively strong rating from a business such as Sustainalytics, which assesses a company’s understanding, disclosure and management of ESG risks, rather than its fundamental environmental impact.

“A company in a hard-to-abate sector can be doing a better job managing its ESG risk exposure by implementing sustainable policies and procedures while concurrently enhancing disclosures and transparency,” compared to a firm that has more modest emissions but is doing little to mitigate its risk exposure, says Tom Eveson, Sustainalytics’ director of sustainable finance solutions for the Americas.

Outside of the oil sector, companies with extensive supply chains prone to environmental and social risks have also attempted to get better financing terms and burnish their green credentials through use of sustainability-linked financing.

Last October, Apical, a palm oil processor in Indonesia, where the industry has been linked to deforestation and poor labour practices, signed a US$750mn sustainability-linked loan with 22 banks based on meeting sustainability targets across its supply chain. The company says it is committed to responsible sourcing and is trying to build a “fully traceable and transparent” supply chain.

Olam, the Singapore-headquartered food giant, has been a heavy user of sustainable lending facilities. The company has been criticised by campaigners for contributing to deforestation in sectors such as cocoa and palm oil.

After securing several sustainability-linked club loans in recent years, Olam signed a US$250mn sustainability-linked RCF with banks including ANZ, DBS and Standard Chartered in mid-2020 tied to undisclosed ESG targets.

It declined to identify the specific targets in the facility, or whether it had met them, when approached by GTR.

Since an adjustment to the SLLPs that became effective in June last year, borrowers have been required to obtain an independent review of their performance towards each KPI at least once a year.

Along with Sustainalytics, organisations carrying out these assessments include EcoVadis, major auditors such as EY and smaller sustainability-focused advisories. EcoVadis said a spokesperson was unavailable for an interview.

The SLLPs say it is “recommended that the verification of the performance against the sustainability performance targets should be made publicly available where appropriate”.

Because a relatively small number of sustainability-linked financings have been signed to date, it remains to be seen how many borrowers will pay heed to this option. Currently, some lenders and borrowers only describe KPIs in vague terms.

“I would hazard a guess that the large, multinational, publicly traded, public stakeholder-facing financial institutions that have instituted these massive frameworks and commitments of net zero etc, will disclose this data, and will enforce it with a certain level of rigour,” Eveson tells GTR.

He says the next few years will be a test not only for disclosure of the arrangements but how they hold up if borrowers fail to meet their sustainability targets.

“For instance, does a financial institution stop lending to its biggest clients when they fail to achieve their goals? What is the downside? What does that do to the sustainable framework of the financial institution when everyone in the company is incentivised to lend?”

“I think the accountability of where this all goes has yet to be proven out in the markets,” he says. “Over the last two years, you went from it being a nice-to-have to a must-have as a licence to operate, and the accountability phase is just around the corner.”

For Rome at Ashurst, the ambitiousness of sustainability-linked loans needs to be closely watched. Guidance attached to the SLLPs says that targets should not be set at “lower levels” than those already adopted by the borrower, which he says leaves companies open to simply inserting targets they had already committed to meeting into the loan details.

“Just lifting previously disclosed targets from a borrower’s annual report and dropping them into a loan agreement is surely not the answer,” he wrote in a note last year. “The borrower is already committed to these targets. Yes, it’s rewarding sustainable behaviour but certainly not driving it.”

“We should be striving for these facilities to really stretch the borrower,” he tells GTR.


Next, supply chains

There is general agreement that sustainability-linked financing is a product whose time has come. During the lead up to Cop26 and at the November 2021 summit itself, a host of countries announced long-term net-zero emissions targets.

Now those commitments have to be met. “I think it’s a given that this market will grow… given the promises that the politicians and financiers have made,” says Rome. “There will be a time when most, if not all, borrowers have a facility of this nature,” he adds.

Over the next two to three years, he expects most borrowers will refinance existing working capital facilities to sustainability-linked loans, because of growing momentum in that direction and encouragement by lenders.

The sustainability-linked bond market has exploded over the last 12 months, Eveson says, and the loans market is likely to follow a similar trajectory.

In recent years several banks have begun offering sustainability-linked supply chain financing (SSCF) products. Until now most have been focused on a handful of large corporate clients.

ANZ, Citi, HSBC, ING and Standard Chartered are among those that have launched SSCF products or incorporated sustainability-linked pricing into existing programmes.

Parvaiz Dalal, Citi’s global head of payables finance, says there is a “strong and positive trend” of clients who had previously considered ESG mainly in the context of big investment decisions but who are now also inserting it into general financing flows.

“All of a sudden the corporates and the large buying houses have started embedding sustainability into their working capital flows,” Dalal tells GTR. Some form of sustainability-linked financing may become the “business as usual” in the future, he says.

Late last year, Citi launched a SSCF programme in Asia with German chemicals and consumer goods firm Henkel and its Australian suppliers as the first participants.

The bank’s Asia Pacific head of trade Kanika Thakur told GTR at the time that the programme will be “anchored around well-established corporates who have clearly defined sustainability objectives across their businesses, including their supply chains, and report their sustainability performance according to industry standards”.

Dalal says the SSCF programme will initially classify suppliers as green, amber or red, based on their sustainability metrics, and will then incentivise strong performers to remain green and laggards to improve performance through preferential financing costs.

Given the ESG risks of global supply chains, such as forced labour, worker safety, environmental degradation and land grabs, sustainable supply chain finance has the potential to trigger major improvements. But many large buyers can have thousands of suppliers, meaning setting targets for each and monitoring their performance can quickly become overwhelming.

“It’s a daunting task,” says Eveson of Sustainalytics. “Most companies are hard pressed to manage the ESG risks within their own four walls of corporate headquarters right now. To suggest that they can then control that of 40,000 companies around the world all at the same time, and then lend, price or procure accordingly is just difficult.”

Eveson says it is a question bending the minds of the supply chain finance industry, with multiple discussions currently underway with financial institutions, tech companies and other industry players.

Technology will help untangle the knot, he believes. As a first step companies need to fully understand their supply chains and then start inserting ESG oversight over the top, beginning with the hard risks and mitigating down.