How sustainability-linked financing works: An expert interview with Catrine Birkevold Liem

As companies work to advance their sustainability agendas, they are increasingly integrating sustainability metrics into their financing in the form of sustainability-linked loans and bonds. Someone working with corporate clients on this on a daily basis is Nordea Sustainable Finance Advisory’s Catrine Birkevold Liem, who brings over 20 years of banking experience to the role. In this interview, she explains sustainability-linked financing in practice and how the growing trend is affecting Nordic corporates.

1. For those not familiar with it, can you explain how sustainability-linked funding works, both for loans and bonds?

Here, we’re referring to loans and bonds for corporate or institutional borrowers, as opposed to other forms of sustainable financing for retail borrowers, such as green mortgages. In the corporate context, sustainability-linked funding is a form of transition financing, where we link the commercial terms of the financing to the company’s capability to deliver on their sustainability targets. All of the other terms are the same as in a standard loan or bond. For loans, the loan can be either a revolving credit facility (RCF) or a term loan. The biggest difference compared to green financing is that a sustainability-linked loan (SLL) or sustainability-linked bond (SLB) can be used for general corporate purposes. In contrast, the proceeds from a green loan or bond need to be dedicated to specific, agreed-upon green activities.

2. How are the sustainability targets linked to the credit decided?

The sustainability targets, or what we call “key performance indicators” (KPIs), should be of high strategic importance to the company. In other words, they need to be material and core to its business. The KPIs are aligned with external benchmarks, where available, to prove that they are ambitious.

To be able to measure how the company is delivering on its targets, it must be possible to follow the progress over the lifetime of a loan or bond. For this, we establish sustainability performance targets (SPTs) to set the level of ambition the borrower has committed to over the lifetime of the financing. The SPTs should be consistently measured over time using a recognised methodology and be based on trustworthy data. For loans, SPTs are set and measured annually. For bonds, they are typically only measured once during the lifetime of the bond, often 3-4 years after issuance.

3. What happens if the company meets or misses the sustainability targets linked to the financing?

For bank loans, if a company reaches its annual SPT, it gets a small discount on the margin the following year. If it does not reach its targets, it has to pay a premium. Typically the annual discount or premium is -/+ 2.5-10 basis points, depending on the company profile or sector. 

For bonds, there is no discount, but a premium to be paid if the SPT is not met. There are a few different ways to calculate the fee. Often it is included as a payment in connection with the repayment of the bond.

4. What kinds of sustainability KPIs are typically used by Nordic corporates for sustainability-linked loans or bonds?

Climate-related targets are by far the most used when deciding KPIs, both targets for the company’s own emissions and emissions in the rest of the value chain, i.e. from suppliers or customers. Over the last few years, the market expectation has moved towards needing to see absolute reduction targets for scope 1 and 2 emissions (emissions from the company’s own business footprint), while we still see either intensity targets, such as CO2 per produced tonne or unit, or proxy targets for scope 3 emissions (emissions from the value chain).

Other kinds of KPIs vary from sector to sector. We often use ICMA’s sector materiality mapping as a reference when discussing the possible KPIs with a company. But it’s important the company feels ownership over its chosen KPIs, so we see variation in KPIs from companies in the same sector. For many sectors, social KPIs are also relevant, such as lowering workplace injury rates or increasing the balance between female and male leaders by a certain percentage over the lifetime of the loan or bond.

Data quality is still an issue, especially for scope 3 emissions targets, where pathways can change as more precise data sources and methodologies become available. (Read more about the MASSIV+ initiative, a cross-industry collaboration to revolutionise the measurement and reporting of scope 3 emissions.)

5. What role do the LMA’s Sustainability-linked Loan Principles and ICMA’s Sustainability-linked Bond Principles play?

The principles for loans and bonds have many similarities. In Europe, they are established by the LMA (Loan Market Association) for loans and ICMA (International Capital Market Association) for bonds. In addition to the requirement of setting concrete and material targets and pathways as mentioned above, the principles explain how to use external reviewers to evaluate the KPIs and SPTs, the expectations for reporting over the lifetime of the financing, and how to structure the impact of meeting or missing the agreed-upon levels within set deadlines.

6. The market for sustainable funding has evolved quite rapidly in the past five years. How is this affecting corporate borrowers?

In the Nordics, we’ve seen a rapid increase in the number of companies using sustainability-linked features in their financing, particularly for our largest clients. Many companies are now facing the first round of refinancing for their sustainability-linked financing. The market has evolved significantly since 2020. Market standards, for example from the LMA, have advanced, becoming more rigorous and clearly defined, and market practice has evolved to meet those standards. Banks now have more stringent routines to evaluate both the ambitiousness and materiality of targets. That has led to a tightening of criteria for acceptable KPIs and tougher milestones to be reached during the credit period – something companies may find challenging at the moment.

However, considering the increasing sustainability reporting requirements in the coming years, such as the Corporate Sustainability Reporting Directive (CSRD) in Europe, we expect it to become easier to set concrete and measurable transition pathways going forward. This will likely ease the workload for a company wanting to include sustainability-linked features in future financing.

While the requirement to prove the KPIs are ambitious has increased, the discount or premium for reaching or missing the targets has generally been stable over the last few years. Going forward, there’s an expectation that banks’ capital requirements will to a larger degree be based on sustainability factors. This may lead to an increase in the suggested premium or discount for companies missing or reaching their sustainability targets.