Plenty of companies say they want to save the planet. It makes for good headlines and warm, fuzzy feelings, but what about investing actual money to back claims of environmental and social responsibility?
Enter the sustainability-linked loan, or SLL.
SLLs are a type of loan where a borrower is incentivized to meet sustainability performance goals by potentially earning discounts on margin rates. The product began in 2017 as a niche of the more well-established green loan market, and now, thanks partly to new global standards and reporting efforts, SLLs are booming.
According to Bloomberg, the SLL debt market grew nearly sevenfold in 2018 to $36.4 billion. In the first half of 2019, the data provider Refinitiv recorded nearly $45 billion of global green loans and SLLs — a 47% jump in volume from the year-ago period. While eco-friendly companies in EMEA have led in the green and sustainable lending space, the greatest regional growth through the first half of 2019 occurred in the U.S., with $8.1 billion in combined new green loans and SLLs.
Funding a Range of Projects
Earlier this year, the global water technology company Xylem decided to replace its five-year $600 million revolving credit facility with an SLL. This was a different approach than opting for a standard green loan, explained Samir Patel, Xylem’s vice president and treasurer. Green loans typically fund a specific project, such as energy improvements or clean transportation. In contrast, SLLs can fund a broader array of a company’s overall sustainability objectives.
Xylem’s sustainability goals are ambitious: the Rye Brook, New York-based company is pushing to prevent more than seven billion cubic meters of polluted water from entering local waterways by 2025, and aims to provide clean water and sanitation services to at least 20 million people.
“We wanted to see how we could really develop and push our agenda with a finance-linked product,” Patel said. “And we took a very holistic view of that.”
To that end, Xylem approached its 15-member bank consortium to discuss a loan linked to the company’s environmental, social and corporate governance (ESG) score, maintained by the independent provider Sustainalytics. Xylem is considered a leader in sustainability in the industrial sector and carries an ESG score of 78 out of 100.
Ultimately, Xylem was able to secure an $800 million revolver credit facility in March. Citibank, JP Morgan, Chase, ING, BNP Paribas and Wells Fargo arranged the facility and were joint bookrunners.
ESG scores measure risk. Banks see them increasingly as a way to assess a company’s exposure to various environmental or social risks and ability to manage these factors, said Trisha Taneja, Sustainalytics’ manager of sustainable finance solutions.
“The idea with SLLs is you can use the money in any way you want, as long as the work goes toward improving the company’s ESG score,” Taneja said. “This particular type of instrument is very well suited to the U.S. market. Unlike green bonds, here the focus is on risk and on managing sustainability risk, and that’s really the direction of the U.S. market and investors.”
Frameworks like Sustainalytics’ ESG system and the Sustainability Linked Loan Principles issued in March by the Loan Syndications and Trading Association (LSTA), Loan Market Association (LMA), and the Asia Pacific Loan Market Association (APLMA) are increasingly cited by analysts as catalysts for continuing SLL market momentum in the U.S. For example, a report issued Tuesday by S&P found that ESG-linked loan pricing could become “a mainstream practice in the debt capital markets.”
A Broader Appeal
Another key growth driver for SLLs is their broader appeal to companies new to the sustainability space. Tess Virmani, associate general counsel for the LSTA, said that while SLLs appeal to sustainability-minded companies that are industry leaders, “we were keen to allow the creativity and innovation of the market to continue, so we wanted to make sure the principles weren’t overly prescriptive.” She added: “(SLLs) should be available to borrowers starting their path to sustainability, so long as they’ve put the thought into it and have a framework around their efforts.”
For Xylem, the appetite for SLLs is clear.
“Once we launched the facility, we did outreach with our constituents, and the feedback was positive — they even told us to go bigger,” Patel said.