Beats | April 24, 2019

An incentive for companies that deliver on sustainability: lower-cost capital

Liz Enochs
Guest Author

Liz Enochs

ImpactAlpha, April 24 – A $3.5 billion line of credit this year for industrial real estate giant Prologis had a novel feature: the interest rate drops each year as long as the company achieves specific sustainability benchmarks.

Last year, United Kingdom residential developer London & Quadrant closed a £100 million ($132 million) loan that included an interest rate discount if the company met a target of helping 600 unemployed residents find work each year.

And Olam, the Singapore-based food giant, last year closed a $500 million revolving credit facility with 15 major banks that lowers its interest payments if it hits sustainability targets.

Olam’s $500 million club loan shows bankers will back sustainable agriculture

Such “sustainability-linked loans” represent a way to “pay” companies, with lower-cost capital, for boosting resource efficiency, mitigating climate risks or improving relations with local communities. The new financial products are based on the proposition that sustainability improvements can reduce costs and risks enough to deliver an acceptable return to lenders even at a lower interest rate.

“If you look at companies, they’re increasingly making public commitments on their sustainability performance and financing is a logical follow on,” said Anne van Riel, who heads sustainable finance in the Americas for the Dutch bank ING. “Sustainability-linked loans are an engagement product, whereby banks engage with their clients on what the main risks are and how they go about mitigating those.”

Globally, sustainability-linked loans totaled more than $36 billion last year, according to Bloomberg NEF, including an $800 million revolving loan to water technology company Xylem, a $181 million loan to Mitsui Chemicals and a $1.19 million facility for Pearson tied to education goals.

Last month, three financial-market trade associations released a set of global principles for sustainability-linked loans. Many loans require a third-party analytics or ratings agency to measure the borrowing company’s performance against pre-set benchmarks for increased renewable energy generation, reduced greenhouse gas emissions, or fewer workplace accidents; or by calculating the company’s sustainability score.

Impact delta

Prologis’ banks were keen to close what may be the first green revolving credit facility for a U.S. real-estate investment trust, said Tim Arndt, managing director and treasurer at Prologis.

Arndt says, “As we got comfortable, we felt it was another place we could be a trailblazer and lead by example.”

Prologis’s lenders will measure the borrower’s sustainability performance each year and adjust the interest rate up or down based on how many green facilities it builds each year. For other companies, pre-set goals can be as broad as an improved sustainability score or as narrow as reducing carbon emissions by a set amount.

The Impact Delta: Change is good for investors focused on environmental and social performance

Arndt would not specify the amount of the discount, but said it was less than 10 basis points, or one-tenth of a percentage point. A $428 million sustainability-linked loan earlier this month from Singapore-based Frasers Property Ltd. featured a 5 basis point rate reduction for meeting ESG benchmarks.

The terms of most sustainability-linked loans don’t restrict the use of proceeds, meaning the funds can be used for any corporate purposes. One of the first loans of this type was a $1.1 billion (€1 billion) revolving credit facility for health technology company Philips led by ING, according to van Riel. The 2017 deal, syndicated through 16 banks, rewards Philips for improving its ESG rating, as measured each year by research and ratings company Sustainalytics.

Since then, more than 50 of these types of loans have been closed, most in Europe. “If you look at the number of deals done here in the U.S., it’s really counted on one hand,” says van Riel.

The new standards may help expand the market. “We just want to do our part in helping break this market open,” said Prologis’ Arndt. “We think this is the next important wave in all this green financing.”