(Bloomberg) — The explosive growth of sustainability-related lending has exposed a number of gaps that need to be addressed in order to avoid greenwashing, according to the global head of sustainable finance at Danske Bank A/S.
As things stand, there are “clear risks,” Samu Slotte, who is based in Danske’s Helsinki office, said in an interview. “There is room for improvement.”
Among these risks is the “quality of the criteria” which determine the interest rate of the loans. Like their cousins in the bond world, sustainability-linked loans carry a rate tied to key performance indicators, rather than the strict product usage model associated with green bonds or loans. The somewhat relaxed requirements have attracted a wider range of borrowers, including corporate giants such as Ford Motor Company. This year, global issuance of these products has soared 212% to $318 billion.
Slotte says it’s “becoming the norm” to discuss sustainability with clients applying for loans. Within two to three years, he expects 75% of Danske’s corporate loans to have sustainability features. It’s a pattern that matches the global proliferation of environmental, social and governance assets, which proliferated to around $35 trillion last year.
The Danske banker says a number of issues need to be addressed if sustainability-linked loans are to live up to their tag. These include key performance indicators, which still require fine-tuning. “KPIs should be material and relevant to the business,” Slotte said. “And they have to be ambitious, so they go beyond the status quo.”
There is also currently no independent verification of performance targets. This potentially exposes sustainability-linked loans to a greater risk of green money laundering than sustainability-linked bonds, which are subject to an external verification process.
The question is partly a question of incentives. For bonds, “arranging banks can say it’s not them demanding it, it’s the investors,” Slotte said. But he doesn’t recall any examples of what’s happening with lending, because “there’s no one the banks can appoint, it’s the investors themselves.”
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Meanwhile, Danske’s efforts to persuade customers to submit to an external verification process often fail. The process “easily starts to back off and the client says maybe we don’t need it at all,” Slotte said. In the end, “it’s usually a question of cost”.
Finally, there is the question of how to structure the pricing of sustainability-related loans. Typically, a lending margin will drop by 2.5 basis points if three KPIs are achieved on an annual basis. Borrowing costs increase to the same extent if the parameters are not met.
Slotte says he hasn’t “seen an instance where the lending margin has gone up, but I’ve seen instances where borrowers haven’t met all of their KPIs, so they don’t get the discount.” . He says this is more typical of the service industry, where metrics tend to be harder to quantify.
The market for sustainability-related debt products has generally been subject to criticism that borrowers do not face significant penalties if they fail to meet their set targets. But Slotte said that could change once the market matures.
“We need to make sure the KPIs are right first before we consider moving the margin, which in itself doesn’t solve the problem,” he said.
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