Looking at the relevance of sustainable finance amid broader market uncertainty, with a focus on corporate loans.
CJ Doherty: Welcome to the Lending Lowdown. I’m CJ Doherty Director of Market Analysis. And this is our fourth podcast in the series and today we are going to talk about sustainable finance, primarily focusing on the corporate loan angle. And I’m happy to say I’m joined by Maria Dikeos, Head of Global Loans Contributions and Director of Analysis here at Refinitiv and our ESG expert extraordinaire. So no pressure Maria.
Maria Dikeos: No pressure CJ, thanks you.
CJ: So then to kick it off, ESG has become such a buzz word in the loans world and indeed the wider world in the last few years. So Maria, can you quantify how much growth we have seen?
Maria: Yeah, I think that's exactly right. We've seen sustainable and green loan pipelines grow astronomically over the last five years. The market went from about $12 billion in 2017 to a new record at $681 billion in 2021. So it's been accelerated growth.
CJ: Yeah, so that’s huge growth. So how did we get here? What has been the impetus for the loan market and indeed the wider market?
Maria: I think that there are a couple of things that have come into play and fueled the expansion. The first is headlines. We're all aware of the environmental concerns and damage as a result of climate change, as well as social inequities based on lack of access to critical services and the like. In the corporate and financial worlds, this sentiment has given rise to more activist shareholders, investors, employees, and basically people want to know that the companies that they're investing in or that they're working for are part of solutions and not contributor to the problem. So that's an important mindset. And finally, I think that there's just been a groundswell of support for ESG and this has increased regulatory rules and oversight. And we've certainly seen that in Europe as a critical driver.
CJ: Okay, great. I know ESG lending was really kick started in the bond market space. What were the drivers there and do they lend themselves to the loan asset class in the same way? And if not, what are some of the differences?
Maria: Sure, I think that's a really good question. I think that the green bond market, which was sort of at the forefront of ESG financing, was fueled by pool of investors and portfolio managers who established internal ESG goals and then sort of created their own dedicated funds which only invest in green instruments. The loan market, in contrast, had less of a committed or green and ESG investor base. So, in the loan space, the drivers for growth have largely been framed by the corporates themselves.
CJ: Okay and from my understanding I think that right now, what we are seeing is an evolution where the finance and corporate communities are working out how to support ESG objectives without impacting company financial goals.
Maria: Yeah, I think you are exactly right. The trick is finding the balance, there shouldn’t be a trade-off between ESG efforts and borrower or corporate P&L goals. So, it's striking that balance.
CJ: Okay great. And so as the importance of ESG considerations grow and evolve, what are the biggest considerations that lenders and borrowers take into account when it comes to deciding whether an ESG loan makes sense or not?
Maria: Sure. I think the most straightforward consideration is use of proceeds. Green loans and social loans are premised on very specific, clearly defined use of proceeds associated with green or social undertakings. I think the trickier area is in the context of individual sustainability linked loans. In these cases, the use of proceeds don't come into play, and it all comes down to whether the borrower has a committed ESG corporate strategy and whether they want to align that with financing.
CJ: And following on from that, I think we have seen a variety of borrowers tapping the market for sustainability linked loans haven’t we.
Maria: Yes, we absolutely have. Investment-grade borrowers globally have certainly been the backbone of sustainability linked loan pipelines. Just to put some numbers on it, 35 per cent of investment-grade loan volume in Europe included sustainability linked components in 2021. And we've seen similar growth in the US, although that's coming off of a lower base. And year-to-date, about 11% of investment-grade US loan volume has ESG metrics associated with it.
CJ: Yeah and on top of that, I know I know we are seeing some inroads being made in the leveraged loan space too, albeit at a slower pace. Progress is definitely occurring in Europe: According to our numbers, ESG lending there has increased from less than 10% of total leveraged loan volume a couple of years ago to roughly 15% today.
Maria: Yeah, and I think that's right. And we've also seen sort of similar growth, slower but similar growth in the US. So just to give an example, in March of this year, Novolex included a $3 billion sustainability linked term loan in it's by buyout financing. So, we're seeing that same, those same inroads being made in the US.
CJ: Right and it’s not a straight upward curve though, is it? You know market volatility can certainly impact efforts and appetite for ESG loans, and I think we certainly saw that with the onset of Covid and the pullback in ESG lending as borrowers rushed to secure liquidity to keep their businesses viable.
Maria: That's right. But I think the reality is that by the second half of 2020, once the immediate liquidity concerns were addressed, we did see ESG pick up again. 2021 was a record year for ESG volume in large part because COVID served as a wake-up call. The reality is that the economic and social impact of something like climate change just remains a daily concern. We see it in the headlines. So, the focus on ESG is not going to go away anytime soon.
CJ: Right and it’s not just companies being good, just being good corporate citizens either. There are borrower incentives in terms of loan pricing as well. I know from our stats that they show better pricing of 2.5 to 5 bps for those that meet their ESG goals. But I guess on the flip side, you might have to pay up if you miss a target.
Maria: That's exactly some of the thinking or the thought process that has to come into play when lenders and borrowers are considering KPIs. On the whole, I think it's really encouraging to lenders when companies like the Renewables Infrastructure Group and Euronav in Europe achieve their goals. And we saw that this year. Ultimately, sustainable finance shouldn't be driving the corporate sustainable strategy. The strategy itself should drive the financing. So lenders want the goals for borrowers to be ambitious, the ESG goals, but they also want them to be achievable.
CJ: Okay, so looking ahead then, what’s next for ESG and the loan market? What should we expect to see in 2023?
Maria: Sure. My sense is that lenders in particular are going to be focused on a couple of things. The first I think is the concept of transition loans, which will be interesting to watch. So those are loans that help brown industry names move toward greener business models and it comes with investment and the like. The second is, I think it's important to bear in mind that with each passing year, we have more ESG comparables and we're building a history so the market should be in a better position to benchmark the impact of ESG loans themselves.
CJ: Okay, thanks Maria, for all your insights. Very informative. But that's all we have time for today. Sustainable finance is a topic we will be talking more about in the future so stay tuned and in the meantime check out our reports and analysis on this topic at loanconnector.com.
And join us in person this year at our annual conference, which is being held November 2 in New York City. Thank you for listening and please subscribe to the Lending Lowdown on Spotify or your favorite podcast platform.
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