Sustainability-Linked Loan for Sustainable Development

As the responsible of a sustainability-linked loan for some years I would like to briefly reflect on this financial vehicle to advance corporate sustainability.

What is a sustainability-linked loan?

A sustainability-linked loan is a joint agreement on the sustainability performance of a borrower. Typically a consortium of financial institutions (lenders) join forces to provide a loan. The loan can then be linked to certain key performance indicators (KPIs) to support the sustainability of the business funded with the loan. KPIs are documented with a methodological approach and yearly performance targets to be achieved. The yearly performance targets are presented (KPI certificate) and reviewed by an external auditor for agreed-upon procedures. Based on the initial agreement the successful achievement will then be rewarded with a premium, or a jointly agreed measure if the ambition has not been achieved.

Is the linkage between finance and sustainability a promising concept?

Linking financial lending to sustainability targets is a promising concept. It closely ties business to efforts for its transitioning towards a more sustainable future. Also, the independent review of the yearly achievements ensures that commitments are closely followed up. The financial industry is exposed to societal demands and needs to ensure credibility and reputation. Banks are well aware of current trends and regulatory requirements across industries with respect to sustainability.

What are some of the caveats of a sustainability-linked loan?

The overall goal to transition the business towards more sustainability needs to be put into the wider context. Financial institutions as lenders make a profit on the loan given. Sustainability is important to ensure compliance, but there are limits in the overall context and each financial institution has its own sustainability agenda. According to the Loan Market Association (LMA) a sustainability-linked loan should define targets beyond legal requirements and targets need to be methodologically sound and measurable, amongst other criteria. Performance is assessed by considering the benchmark and extrapolate past performance into the future. Again, although it is sound from an investor perspective to focus on risks and performance, sustainability is not as established in methodology as for example financial reporting. This limits the scope of measures that are feasible to propose, for example pilot projects in developing countries with an uncertain outcome are unlikely to be accepted by banks as part of the sustainability agreement of the loan. The banks should engage in their commitment to develop sustainability-linked loans beyond a "tick-the-box" exercise.

How important are sustainability-linked loans for sustainability development?

Looking back I am of the opinion, that the commitment of financial institutions to support the transitioning towards a more sustainable future is essential. I believe as a society we have not yet fully acknowledged how essential this commitment really is for sustainable development. The financial flow drives underlying efforts and the independent audit ensures credibility. Sustainability-linked loans are still rather an exception, and not the rule. It remains to be seen how this will evolve in the future and compared to other measures, such as green-bonds for example.