ESG-linked loans fall out of favour, for now
Asset managers have cooled on sustainability-linked loans (SLLs) this year, due to the higher reporting requirements and the time and money required to structure loans with ESG covenants and ratchets.
In 2021 and 2022 around half of European leveraged loans included sustainability-linked features, but in the first half of 2023 this was down to 23 per cent, according to Reorg. Meanwhile, the size of SLLs structured as of November was nearly 50 per cent lower than in 2022, according to Environmental Finance.
In addition to the extra cost of structuring such loans, there are also concerns over the credibility of SLLs, which will be further scrutinised in 2024, according to Sustainable Fitch.
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Asset owners are likely to investigate how investments can deliver real impact, Sustainable Fitch noted in a report, with the lack of robust KPI selection becoming a central concern.
“KPIs need to be relevant, core and material to the borrower’s overall business, measurable and able to be benchmarked. However, some market participants expect half of the SLLs to fail to set robust KPIs, according to research by the Financial Conduct Authority in June 2023,” the report noted.
Meanwhile, research from Covenant Review found that investors had negative perceptions over “sustainability washing” and the overcomplexity of ESG-related provisions have led to the rejection or removal of the ESG ratchet in loan deals in Europe.
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In a recent event hosted by KBRA and European Leveraged Finance Association (ELFA) it was noted that navigating ESG disclosure can be very challenging, with speakers highlighting the need for enhanced engagement and better dialogue between investors and borrowers.
Despite some of the concerns, many are highlighting the ESG-linked loan market as a growth area. According to private debt manager Alcentra, cumulative sustainable lending globally totalled $308bn at the end of September, with SLLs accounting for 86 per cent of total volumes.
“Despite the slowdown in primary issuance during 2023 due to the geo-political landscape and challenging macroeconomic backdrop, ESG remains at the forefront of developments in the European leveraged loan market,” Alcentra noted in a recent report.
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