Trade finance experts are calling for a “complete rethink” on greenwashing, following warnings from UK regulators that sustainability-linked lending is being held back by weak incentives and conflicts of interest. 

The Financial Conduct Authority (FCA) is increasing scrutiny of loans that are tied to sustainability targets, writing to heads of ESG across the banking sector last month to warn of “potential market integrity concerns”. 

There is a risk lenders are not sufficiently incentivised to set tough sustainability targets for their borrowers, or to impose meaningful step-ups in margins where targets are missed, it says. Borrowers may also be discouraged from seeking sustainability-linked loans if costs, complexity and potential penalties are deemed too high. 

“There are some issues holding back more widespread adoption and market growth,” says Sacha Sadan, ESG director at the authority. “We want to build trust and integrity in these products.” 

For loans where borrowers can make savings on margins if they hit sustainability targets, the authority says those benefits “may be outweighed by costs and negotiation time with lenders or legal advisers”. 

Borrowers may also fear reputational damage if they miss targets, reducing the incentive to seek a sustainability-linked loan. 

And in situations where targets are missed, the FCA notes that step-ups in margins have not increased despite rises in global interest rates. 

For investment grade borrowers, those steps-up appear to be capped at around 0.05%, it says. For lower-rated and leveraged loans, typical figures are around 0.25-0.3%. 

The regulator adds there could be a conflict of interest internally in situations where banks have set ESG financing targets, particularly if incentivised by remuneration for staff, as that could encourage lenders to accept weaker KPIs from borrowers. 


Lack of clarity 

Rebecca Harding, an independent trade expert with consulting firm Rebeccanomics, suggests lenders are struggling with a lack of established definitions and reporting practices around sustainability-linked lending. 

“The definitions of a sustainability-linked loan are vague and vary between banks,” she tells GTR 

“They are priced differently as well, and differential interest rates are being used by banks, but not necessarily profitably. Because definitions are unclear, and penalties likely to be high and punitive, it is likely banks will be less ambitious in the way they define a green or sustainable loan.” 

Harding adds that interest rates and capital liquidity ratios also have to be considered, as giving preferential treatment to sustainability-linked loans through lower interest rates alone “will not be a game-changer in terms of how the market works”. 

“Without a complete rethink of how the finance industry can work with regulators to improve definitions and reporting standards… the scope of the market to default to business-as-usual, with some products repackaged in unambitious sustainability wrapping, will always be there.” 

Jason Marett, a senior associate at HFW, adds that there is “little market guidance” on the use of trade finance instruments linked to sustainability goals. 

“For example, in the agri sector, banks are issuing letters of credit with sustainability linkages,” he tells GTR. “As with sustainability-linked loans, these products may count towards banks’ green finance targets, so there are greenwashing risks if these products lack scrutiny.” 

However, Marett suggests that the FCA’s growing focus on the topic “might encourage banks to start including more ‘teeth’ in sustainability-linked loan documentation, for example so that borrowers that fail to deliver sustainability reports are at risk of triggering an event of default and an acceleration of the loan”. 

“This would be a significant market development,” he says. 

The lawyer adds that commodity finance lenders are likely to increase use of external ESG consultants to assess the robustness of sustainability targets, and that developments in supply chain due diligence regulations and technology – such as satellite mapping showing deforestation – could also bring improvements. 

In Europe, the value of sustainability-linked loans totalled US$243bn last year, down from US$319bn the previous year, according to data provider Dealogic. 

However, it notes that ESG lending increased as a proportion of overall activity, amid a wider decline in loan volumes. Dealogic finds that in the first quarter of this year, loan volumes in Europe, the Middle East and Africa fell to their lowest level since 2009. 


Next steps 

The FCA says it does not currently plan to introduce regulatory standards or a code of conduct, but “will reconsider this if the market needs it”. 

“We will continue to monitor this market as part of our wider work on transition finance, with a view to considering the need for further measures to support the development of a robust transition finance ecosystem,” it says. 

The authority’s letter is the latest of several efforts to tackle greenwashing in the lending sector. In November 2021, the regulator warned it was receiving a “growing number of low-quality authorisation applications from ESG-themed funds”, whose sustainability claims “did not stand up to scrutiny”. 

HM Treasury noted at the time that the authority was taking a hard line against such companies. 

Worldwide, nearly a fifth of greenwashing allegations last year arose in the financial sector, according to a report published last month by the European Banking Authority. The EU regulator said it would consider changes to regulatory frameworks following concerns over financial institutions’ backing of fossil fuel companies, mining operators and companies linked to deforestation. 

In trade finance, however, industry insiders warn that increasing complexity and cost around sustainable lending requirements could worsen access to finance for smaller suppliers, particularly for short-term or high-frequency transactions.