How ESG-linked lending helps hold companies accountable
Virtue can bring rewards, as more and more businesses are discovering when applying for a loan. Some banks offer rebates to borrowers if they meet targets for reducing pollution, reducing food waste, or even helping job seekers. To give the incentives some teeth, there are penalties for missed goals. Global issuance of loans linked to borrowers’ environmental, social and governance performance jumped to nearly $500 billion in 2021, from $4.9 billion in 2017 when the first such agreement was created, the companies looking for options to present themselves as socially responsible.
The agreements are set up like normal loans or revolving credit facilities, often with a group of banks providing funds to the borrower. Traditional loans are priced against a benchmark rate used in interbank lending, such as Euribor or the Secured Overnight Funding Rate (SOFR), and borrowers pay a premium, or spread, in plus the reference rate, depending on factors such as credit ratings and the transaction. length. A sustainability-linked loan has an additional twist, discount or spread penalty that depends on the borrower achieving specific ESG goals. For example, the interest rate of a loan can be 100 basis points above Euribor and can be adjusted according to the ESG performance of the borrower.