New ICMA guidance aims to bring integrity to opaque sustainability-linked loan market

Developed alongside London-based Loan Market Association (LMA), the guidance for the novel product – which has only seen two issuances to date – is aimed at banks looking to fund, in part or in full, a portfolio of eligible sustainability-linked loans (SLLs) through public debt markets.

Since making its debut in 2017, SLLs – which are similar in structure to sustainability-linked bonds (SLBs), in that the interest rates vary according to a borrower’s sustainability performance – have ballooned into a US$1.5 trillion market, second only to the global green bond market.

Unlike green and other use-of-proceed bonds overseen by ICMA, banks can use the SLL label without strictly applying the principles set out by LMA and other loan industry bodies, as it is an unregulated private product, often extended to small- and medium-sized companies. But the potential reputational risks involved in the misuse of the label has not stopped many lenders, including some of the largest in Asia, from counting SLLs towards their sustainable financing targets.

With SLLBs, banks could be incentivised to subject their SLLs to more accountability and scrutiny over the longer-term.  

Sustainability-linked loans volumes more than halved in 2023 compared to the year before, driven in part by greenwash concerns in the market. Image: Loan Market Association

The only two SLLB transactions thus far have been completed by Helsinki-headquartered Nordea Bank, which pioneered the concept in 2022.

But Alban de Faÿ, vice chair of ICMA’s Executive Committee of the Principles, as well as the head of ESG and green fixed income processes at Amundi, said that investors have expressed willingness to look into investing in this new bond instrument in a survey they conducted earlier this year.

“As this market is accelerating, we want to be sure if we have new traction, we are able to provide clear guidance from the beginning to be sure that we have a consistent market,” de Faÿ added.

ICMA, which has been careful to stress that the new use-of-proceed bonds “should be considered a separate category” distinct from the established catalogue of green, social, sustainability or sustainability-linked (GSSS) bonds, has proposed two possible approaches for screening the underlying loans which make up the SLLBs. 

The first takes a portfolio-type approach, which requires a detailed disclosure of how a bank’s loan collection aligns to the five core components of the LMA’s SLL principles, including the relevance of the pre-selected key performance indicators (KPIs) and the accompanying sustainability performance targets (SPTs), while making reference to ICMA’s KPI registry – which has just been expanded to include biodiversity and circular economy themes.

The approach entails seeking an independent external review for each eligible SLL in the portfolio with a high-level description of the borrowers’ sectors, selected KPIs and intended sustainability objective.

But ICMA’s deputy chief executive officer and head of sustainability Nicholas Pfaff pointed out that this latter approach might only make sense “if there is not a very high number of SLLs and there is a great deal of commonality”. Otherwise, for banks with a larger number of smaller loans on their balance sheet, it might be costly to do an external review relative to the size of the loans.

Given the complexity of this nascent bond category, ICMA will need more time to consider whether to translate the SLLB guidelines into concrete principles, said de Faÿ. 

Isabelle Laurent, chair of the Principles and deputy treasurer of the European Bank for Reconstruction and Development (EBRD) concurred that ICMA will need to see how this instrument develops.

“You’re talking about mixing a use-of-proceeds instrument with somebody else’s KPIs and other factors. So I think it will take time to understand whether or not that works in practice in a way that when there’s any changes in the underlying bilateral loan, that’s easy to translate through to a bond,” said Laurent.  

Nordea Bank currently absorbs any coupon adjustment from the underlying SLL portfolio and offers bondholders a fixed rate, in order to meet European Union’s regulatory capital requirements. However, some other banks, like Bank of China which issued a similarly structured bond, might choose to pass on the coupon adjustment for SLL borrowers, pegged to whether they meet their KPIs, to investors.

Laurent said that another reason ICMA has not established separate principles for SLLBs at this point in time is due to concerns around the double counting of SLLs, which could already be underlying assets in an issuer’s GSSS bonds.

Tackling greenwash in ‘green enabling projects’

ICMA has also released guidance for what sort of “green enabling projects”, or supply chain activities vital to green projects, could qualify for financing through green bonds. Under the guidance, mining and metals for batteries going into electric vehicles, for instance, could be mapped to the clean transportation category for green projects.

Other sectors that could be mapped to green projects include building and construction supplies, chemicals and specialty chemicals, information and communications technology (ICT) and telecommunication networks and the manufacturing of industrial parts and components. 

“It isn’t the fact that you couldn’t do it before, but it’s trying to ensure that there is rigour around the requirements, so people are very clear when they’re using use-of-proceeds green bonds for these kind of projects, what the expectation is in terms of reporting,” Laurent told Eco-Business, adding that the document is meant to reduce reputational risks, or greenwash, associated with financing activities which might not all be green upfront.

Projects will need to meet four specific criteria. Firstly, they need to clearly identify and contextualise why they are necessary in a certain green project’s value chain. 

Next, there cannot be any carbon lock-ins, meaning these solutions should already be technologically feasible and commercially viable. In particular, the guidance specifies that the transition away from fossil fuels “should be considered in light of national, regional and/or sectoral transition plans”, which could take reference from nationally determined contributions under the Paris Agreement or taxonomies.

Thirdly, they must provide a clear, quantifiable and attributable environmental benefit, with the guidance recommending that the green enabling projects be mapped to one or more eligible green project categories listed in ICMA’s Green Bond Principles.

Lastly, the projects must demonstrate that they have mitigated adverse social and environmental impacts identified, so that investors can make an informed decision on the net green merits of the activity.

Further guidance will be provided this year at the sectoral level, said Pfaff.

In response to queries at the media briefing, Pfaff said that ICMA’s position on transition has not changed since they updated their Climate Transition Finance Handbook (CTFH) last year.

“The best way to look at transition is as a theme and at the organisation level,” said Pfaff, who reiterated that ICMA does not see a need to create a transition label for projects.

However, he acknowedged the work that some jurisdictions, like Japan, have done in developing a climate transition label based on the use-of-proceeds approach, underpinned by official sector guidances and industry-specific pathways. “We made it clear in the CTFH that this is absolutely fine,” he said.

“On the investor side, we are very happy to have one standard, like green bonds, then dedicated communication on the specificity of the green bond. For example, if the green bond is dedicated to water management,” said Amundi’s de Faÿ, instead of perhaps calling it a “blue bond”. 

“We try to avoid having a different nickname because it’s sometimes confusing. And if we want to have a market with a consistent standard, we have to also take into account that some investors have dedicated green analysts analysts, but others do not have sufficient resources to look at this market. So we have to make it simple,” he said. 

Driven partly by the drop in sustainability-linked loan volumes over the past year, LMA has convened a working group to investigate if an additional “transition” loan label is required to allay transition-washing concerns –an emerging variant of greenwash which environmental law charity ClientEarth flagged last year and recently proposed new legal guardrails to combat.

ICMA, which is a participant in the group, is closely following the outcome of these discussions, Pfaff shared. “One of the nice things… is that the initiatives and innovations in the loan market are transferable to the bond market, and vice versa.”