Sustainable finance and ESG

Banks, insurers, and other financial institutions face immense challenges from the upcoming tsunami of ESG regulations from the EU.

In coming years, as a result of the enactment of the Corporate Sustainability Reporting Directive (CSRD) and the directly applicable European Sustainability Reporting Standards (ESRS), the number of entities required to report on sustainable development in Poland will increase to around 3,500. The existing soft principles of corporate social responsibility (CSR) will be replaced by stringent ESG requirements, including the measurement and disclosure of environmental, social, and governance impacts. Failure to comply with reporting obligations will result in management liability and tangible penalties. And smaller entities within the value chains of larger companies will also need to respond to ESG-related inquiries in surveys received from companies required to report on ESG. Therefore, the number of entities that can ignore this paradigm shift in business conduct is minimal. All market participants should address this issue, bearing in mind that adequately addressing these matters in advance will translate into building a competitive advantage.

The EU, as a leader in sustainable development, aims to transform its economy into a zero-emission model through a series of policies and legal initiatives, the most significant being the European Green Deal (EGD). Sustainable finance plays a key role in the EU’s plans to transition to a zero-emission economy, constituting a central element of the EGD. This plan aims to make the EU the first climate-neutral economy by 2050. Achieving this goal requires massive investments in green technologies, renewable energy sources, energy efficiency, and other sustainable development initiatives, highlighting the importance of sustainable finance.

The EU is introducing regulations to direct capital towards sustainable investments. Its taxonomy system sets out criteria that economic activities must meet to be considered environmentally sustainable. This aims to eliminate greenwashing and promote transparency in sustainable financing. In summary, sustainable finance is a key tool for the EU in its quest to achieve climate neutrality by 2050. The upcoming wave of regulations aims to promote sustainable investments and limit the ability to finance ‘dirty’ investments.

Sustainable financing

Sustainable financing encompasses transactional aspects such as raising external financing by borrowers and bond issuers. The most popular financial instruments remain loans and bonds. In this context, it is essential to focus on sustainable loans, their characteristics, benefits, and whether they are worthwhile.

Sustainable loans

Support for green loans and sustainability-linked loans is provided by non-binding guidelines: the Green Loan Principles (GLP) and the Sustainability Linked Loan Principles (SLLP) published by the Loan Market Association (LMA). The LMA defines green loans as credit instruments used to finance or refinance green projects. Examples of projects that meet green loan requirements include:

• Renewable energy projects: investments in renewable energy sources such as solar, wind, hydro, geothermal, and biomass energy, contributing to the reduction of greenhouse gas emissions.
• Energy efficiency: projects aimed at significantly improving the energy efficiency of buildings, industrial facilities, and production processes, resulting in reduced energy consumption and CO₂
• Water and wastewater management: investments in water resource management systems, wastewater treatment plants, and water recycling systems that contribute to the protection and sustainable use of water resources.
• Sustainable urban development: projects related to green infrastructure, sustainable urban transport, eco-friendly buildings, and green spaces that promote the sustainable development of cities.
• Biodiversity protection: projects for the protection and restoration of biodiversity, such as nature reserves and the protection of marine and terrestrial ecosystems.
• Sustainable land management and agriculture: investments in agricultural practices that promote sustainable land use, reduce erosion, and improve soil quality.
• Clean transport: projects promoting low-emission transport, including the development of infrastructure for electric vehicles, investments in public transport, and cycling systems.

Obtaining a green loan involves greater organisational effort for the bank and the borrower compared to a traditional loan, but this can be offset by benefits such as:

• Potential cost benefits
• Alignment with the company’s sustainability goals
• Better risk management
• Reporting and transparency
• Positive public image
• Compliance with LMA standards – avoiding greenwashing
• Access to a broader investor base
• Market recognition

Another category of sustainable loans is the sustainability-linked loans (SLL). SLLs encourage borrowers to achieve significant, ambitious, predefined, regularly monitored, and externally verified sustainability goals through key performance indicators (KPIs) and sustainability performance targets (SPTs). A key element of this type of loan is the sliding margin mechanism, adjusted based on the achievement (or lack thereof) of predetermined sustainability goals. Borrowers are increasingly developing sustainability (ESG) strategies, integrating them into their business strategies, and aligning financing mechanisms with their sustainability commitments. Entering into an SLL agreement in this context can have several benefits for borrowers, lenders, and/or investors:

• Building stronger, value-based relationships with stakeholders
• Positive impact on reputation and credibility
• Inclusion of environmental, social, and governance (ESG) performance in lenders’ credit assessments
• Increasing the borrower’s ambition for ESG performance
• Engaging lenders to support significant improvements in sustainability by actively directing capital towards the implementation of the borrower’s sustainability strategy
• Demonstrating commitment to achieving sustainability goals with correlated economic impact
• Promoting sustainable long-term growth and profitability

Before a company seeking a loan approaches a specialised bank working with experienced advisors in such transactions, it can consider the following questions to facilitate the decision on product selection:

• Would you benefit from taking out a loan with ESG attributes?
• Are there commercial, financial, and/or operational benefits?
• Is this a key part of your sustainability/ESG strategy?
• Is this something stakeholders expect?
• Do you have a specific sustainable project in mind that requires financing?

Particularly for SLLs, can you identify relevant KPIs/SPTs significant for your sector and organisation?

• Do you have available data?
• Do you have historical data available?
• Have you set short-, medium-, and long-term goals for some of your objectives?
• Do you have appropriate goals that cover the loan period or part of it?
• Are the available data reliable, robust, and verifiable?
• Do you have a set of KPIs that you already track?
• Are your KPIs/SPTs aligned with your long-term ESG strategy?
• Do the SPTs go beyond regular operations?
• Is the data comparable?

Summary

According to a survey conducted by the LMA at the end of 2023, 33.3% of its members who took part indicated that the biggest obstacle to integrating ESG factors into the syndicated loan market is the availability and quality of ESG data. With the enormous increase in the number of entities required to collect and disclose sustainability data (as required by the CSRD), we will observe an ever-greater quantity and availability of company data, which can help banks structure and service sustainable loans. What is currently an additional effort will soon be easily exportable to the bank. Additional burdens will be minimised, and tangible benefits will remain. Companies that anticipate this trend in advance will gain a significant competitive advantage in the market in which they operate.