The sustainable loan market and the commodities sector: what is it, what’s new and what’s to come

In Part 2 of our series on Responsible Business, Sustainable Finance and ESG, we focus on the sustainable lending market: we take a look at the main issues in loan structuring, the latest guidance on green lending and loan-related. sustainability, we ask what is new for the raw materials sector and consider what is to come.

Briefing series on responsible business, sustainable finance and ESG.

What are the main sustainable loan products?

The two main sustainability products in the loan market are green loans and sustainability loans.

Green loans are generally structured the same way as other syndicated loans, except that the purpose of the loan is to finance a qualifying “green project”.

Sustainability loans, on the other hand, are structured in such a way that the loan motivates a borrower to meet their sustainability goals. This usually takes the form of a reduction in the margin that can be triggered when sustainability goals are met. Importantly, the proceeds from a sustainability loan do not need to be used for specific purposes, making them more flexible products than green loans.

In the loan market, green and sustainability loans are now mainstream products. In 2019, over USD 160 billion in green and sustainability-related loans were issued. There was a slight decrease in volume in the first half of 2020 compared to 2019 but we expect emissions to increase in the second half of this year.

Are there any guidelines for the use of these products?

LMA, LSTA and APLMA1 released new guidelines on green lending and sustainability lending in May 2020. These followed the release of the industry first major principles on these products in 2018 and 2019. The new guidelines may have to have escaped the radar for those in the market who were busy negotiating with the impact of COVID-19. Their aim is to promote the development of the sustainable loan market by giving clear guidance on how the principles should be applied and to reduce the risk of “green-washing” – when green or sustainability labels are misused.

The new directions are timely, as sustainability issues are back on the agenda, especially in the commodities sector. It makes it clear that green loans are not just for “green” businesses; any borrower can enter the green loan market as long as the loan is structured in the right way. For the commodities sector, this means that even so-called “brown” industries may be eligible provided there is an appropriate commitment to decarbonization. These loans tend to be labeled as “bridging” or “light green” loans.

The sustainability loan guidelines make it clear that these loans can be structured with two-way pricing. This means that besides an incentive to meet sustainability goals, there may also be a margin premium if the company does not meet the goals. We are already seeing this type of pricing adopted in the market.

What types of sustainability goals are relevant?

The Sustainability Lending Principles released in 2019 provided a list of 10 common categories of sustainability goals, including a range of green and social issues such as greenhouse gas emissions, sustainable agriculture and renewable energies. As the market has grown, we have started to see more personalized and carefully structured targets that are specific to the particular industry and the sustainability profile of the borrower.

Figure 1 above shows some of the sustainability goals in the Geneva-based commodities market. In the agricultural sector, for example in the soybean and coffee sectors, targets could relate to the traceability of supply chains. As an example, we advised Sucafina – a multinational coffee merchant – on a sustainability related loan with goals related to training and capacity building of smallholder farmers in East Africa. In the energy sector, we have seen targets on environmental issues like carbon emissions and water management, but also social issues like worker safety.

Why are sustainable loans important for commodities?

Sustainable finance is increasingly important in the commodities sector. This is in part due to the tightening of other sources of financing for raw materials, even before the impact of COVID-19. A number of banks have withdrawn from trade finance altogether in recent months and there is pressure on the financing of extractive industries in particular, as the views of the public and banking actors evolve.

If companies in the commodities sector can align their activities to meet the main sustainability goals of their industrial sector, they may be able to access a wider range of financing. Small traders and producers may be able to tap into a larger capital pool and potentially improve prices as well as position their businesses for long-term sustainability.

What’s up?

In our briefing2 in February, with many industry players, we predicted a continued increase in green bond and sustainable loan issuance in 2020. Then, in early March, COVID-19 significantly affected European markets and global trade and we noted a sharp decline in the number of sustainability-related emissions, as well as predictions of a decrease in the importance of sustainability issues.

It now looks more like a temporary disruption than a roadblock. In the sustainable bond market – the most mature sustainable finance product – total issue volume was higher than ever in the second quarter of this year. In the first half of 2020, total volumes increased by 47% compared to the same period in 2019 to reach almost USD 200 billion (see Figure 2).

What comes next?

Despite a slight pause in new lending as the market faced the immediate impact of COVID-19, there now appears to be a resurgence of interest in sustainability and ESG issues, including in the commodities sector.

Some research on the impact of the pandemic suggests that the disruption of markets and economies has caused a shift in the way companies perceive green and sustainability issues which are now higher on the agenda; this includes climate change and ecological issues, but also social issues – for example around transparency of supply chains and employee safety and human rights – all of which are highly relevant in the context of raw materials.

The global regulatory environment is also changing; new European regulations will make disclosure of ESG issues compulsory for certain companies. A new EU-wide system for ranking green and sustainability issues is also likely to have an impact on how the loan market develops.

While there were early predictions that COVID-19 would distract from sustainability issues, there are now signs that lenders and borrowers are increasingly taking them into account. The durable loan market is now clearly dominant.

Priscilla C. Carnegie