05-07-2023 15:25

Beyond climate: Sustainability-linked loans embrace diverse targets

Loans linking borrowing costs to sustainability targets have surged in recent years. While sustainability-linked loans have tended to focus on climate-related goals, borrowers are increasingly going beyond climate to include social targets in their financing. Nordea’s Sustainable Finance Advisory team, with local experts in each Nordic country, is focused on helping clients select the right targets for their specific situation.
Closeup shot of an adult and child holding a plant growing out of soil

Sustainability-linked loans (SLLs) were quick to catch on in the Nordics as a transition financing tool. Use of the structure surged in 2021, and SLLs remain a popular choice for companies seeking to integrate environmental, social and governance (ESG) goals into their financing. Today, close to 25% of all loans to large corporates in the Nordics have a sustainability link. 

While SLLs have tended to focus on climate goals, an increasing number of companies are including additional targets that cover other important sustainability themes across ESG. Social issues, such as diversity and inclusion, and health and well-being, have gained increased significance for investors, companies and society at large. SLLs are a way for companies to signal to stakeholders their efforts to address their different sustainability priorities.

However, selecting the right KPIs and figuring out which metrics to use to track progress requires an in-depth case-by-case analysis. That’s where Nordea’s Sustainable Finance Advisory team is well-equipped to help, with local sustainable finance experts based in each Nordic country.

What is a sustainability-linked loan?

Sustainability-linked loans are a type of lending arrangement where the company’s borrowing costs are tied to its progress on meeting certain set and measurable annual sustainability targets. If the company meets those key performance indicators (KPIs), it gets a discount on the interest paid. If not, it pays a premium.

Improving the overall footprint

SLLs give borrowers an incentive to pursue sustainability targets by tying the pricing of the loans to the achievement of pre-determined key performance indicators (KPI). The borrower pays less interest if it hits the KPI and more if it misses.

While green loans can only fund projects that make a substantial contribution to environmental objectives, SLLs open up sustainable financing to borrowers in any sector, including in carbon-intensive industries. Companies can also use the general, all-purpose financing from an SLL more freely than the use-of-proceeds funding from a green loan, which is earmarked for specific green projects. In that way, the SLL is designed to support a borrower on its overall transition journey.

Jacob Michaelsen, Head of Sustainable Finance Advisory at Nordea, calls transition finance “the major thematic driver for the financial market in the next decade.”

“Whether climate related or otherwise, we need to start addressing the issue of how we can incentivise companies to improve their overall footprints. SLLs are a great way to do that,” he says.

Nordea ranked best Transition/Sustainability-linked Loan bank in Western Europe

Global Finance in 2023 named Nordea the #1 bank in Western Europe for outstanding leadership in Transition/Sustainability-linked Loans. The bank has been driving innovation in the field, with the launch in 2022 of its novel Sustainability-linked Loan Funding Framework. Nordea has raised EUR 400 million from a bond issued under the framework to support its sustainability-linked loan financing activity.

Find out more

The rise of social targets

The targets in SLLs have historically focused on the E in ESG, for example, covering greenhouse gas emissions or energy efficiency. Climate change is a global issue, and with the Greenhouse Gas Protocol and environmental reporting standards, the E sphere is more mature and defined by more quantifiable metrics, making it more obviously suited to target setting.

Social targets, on the other hand, often have local nuances by country or community. They are also challenged by a lack of standardised metrics and market benchmarks as well as limited data about companies’ past performance on social issues. Yet, despite these challenges, companies are branching out to new types of KPIs beyond climate. Data from Dealogic reveals that of the 63 SLLs with publicly-disclosed KPI themes, 46% since 2019 have included at least one social KPI.

Share of SLLs with publicly-available KPIs that include at least one KPI with a social theme (2020-2022)

Source: Dealogic, Nordea

As the high-level themes that SLLs aim to address have increased across E, S and G, the types of specific issues targeted within the social theme have also diversified over time. Although some standard practice is beginning to emerge with regard to the inclusion of health & safety and gender diversity metrics, which together make up 55% of publicly-disclosed social KPIs since 2019, borrowers now appear to be embracing a broader range of social KPIs.

This is only possible as long as adequate resources are dedicated to assessing social KPIs and ensuring that they remain material, feasible and ambitious, says David Ray, ESG Specialist at Nordea Sustainable Finance Advisory.

He notes that while including social KPIs can give borrowers an incentive to address the social impact of their activities, thereby broadening the potential impact of sustainable financing, such KPIs should only be included once the underlying impact areas are understood. That requires a local, situation-specific assessment.

“It is vital that social KPIs act to improve long-term outcomes and not merely incentivise surface-level changes. Borrowers and lenders must therefore work together during the target-setting process, ensuring that adequate time and resources are dedicated to the task and that sufficient data and tools are available,” says David Ray.

Publicly-available social KPI themes (2019-2022)

Source: Dealogic, Nordea

Starting point: the company’s material issues

When it comes to figuring out how to structure an SLL and other sustainable finance structures, companies are increasingly turning to their bank for guidance, says Juho Maalahti, Nordea’s Sustainable Finance Advisory country lead for Finland.

“Clients expect to hear more tailormade and thought-through proposals, for example on KPI considerations from selection and calculation to target setting and reporting,” he says. Understanding the local context and how it factors into the company’s specific situation is crucial.

While banks have, under regulation and supervision, largely focused on greenhouse gas emissions-related metrics, “we also have clients in sectors where emissions do not necessarily drive a significant positive or negative contribution to climate change,” adds Juho Maalahti. “In these cases, our understanding of the client’s business and ability to draw relevant conclusions, while bearing in mind market dynamics and technical requirements, is even more important.”

Nordea's Isabella Frenning Willis (left) and Juho Maalahti (center) with Global Finance Founder and Editorial Director Joseph Giarraputo (right) at the Global Finance 2023 Sustainable Finance Awards in London
Companies want their KPIs to tell a more holistic story of their strategic sustainability goals that doesn’t only focus on the environment but also cares for the employees, the customers and the value chain.

Isabella Frenning Willis, Nordea Sustainable Finance Advisory, Country Lead for Denmark

Isabella Frenning Willis, Nordea’s Sustainable Finance Advisory country lead for Denmark, notes that the starting point for identifying the right KPIs is always the company’s material issues and, in particular, addressing any negative impacts the operations and value chain may have. For many companies, that does mean reducing their greenhouse gas emissions, but not for all, she adds:

“For some companies, the main impact is on social issues, and in those cases that is obviously what is relevant to address with KPIs. Across the board, companies also want their KPIs to tell a more holistic story of their strategic sustainability goals that doesn’t only focus on the environment but also cares for the employees, the customers and the value chain.”

Find out more about how to integrate social impact into financing in this article

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