The chaotic new world of rising interest rates isn’t having a noticeable impact on new issuance of ESG-linked subscription lines, but some lenders are more cautious about regulatory risk in the ESG sector, and some issuers have switched from ESG-linked lines to normal ones, sources say.
This year, the SEC’s new ESG task force took action against BNY Mellon for greenwashing, resulting in a $1.5 million penalty (without a confession of wrongdoing by the institution), and Goldman Sachs is facing an SEC probe into some of its ESG Funds. German law enforcers also raided Deutsche Bank on suspicion it was fraudulently advertising sustainable investment funds managed by its DWS unit.
Fund finance pros reported varying levels of activity so far this year, from a modest decrease to an actual uptick in activity.
“The market as a whole has slowed relative to the torrid pace we saw coming into the US in late 2020, and then obviously through 2021,” says Wesley Misson, head of fund finance in the US for law firm Cadwalader, Wickersham & Taft. He says Cadwalader closed eight ESG-linked facilities last year, while the figure stands at just four so far this year.
Misson, who works with clients on the lending side, adds that he’s working on two more facilities, which could raise 2022’s total to six closed. Cadwalader would have met or surpassed its 2021 figure were it not for flips of some ESG-linked sub lines to regular ones during their transaction processes, he believes.
More about headwinds
“I think it’s less related to interest rates rising and the tougher bank financing environment we’re in currently, and more probably related to the regulatory headwinds and scrutiny around greenwashing that’s more specific to the ESG sector as a whole,” he says.
Banks aren’t getting breaks on their risk-based capital requirements when they are engaging in ESG lending, Misson says, which means extending pricing discounts lowers their capital without a benefit in return. That naturally suppresses the supply side, and the increased scrutiny around ‘greenwashing’ only exacerbates the issue.
Some lenders are even reassessing existing lines they extended last year to see if they still qualify as ESG, says Vicky Du, global head of fund finance at Standard Chartered. She cites regulators who are issuing requirements and clearer guidance for the space as one cause. She also says newer ESG-linked sub lines are more thoughtful. As an example, they include broader ESG frameworks instead of just listing one or two KPIs to watch.
This increase in caution has led some would-be borrowers of ESG-linked lines to switch to conventional ones. Those borrowers who have switched to regular sub lines from ESG-linked ones have done so when parties are unable to agree on what sort of outcomes are meaningful when it comes to ESG, Cadwalder’s Misson notes.
Banks make widely varying requests to borrowers for compliance in order to get the interest-rate breaks, Adam Summers, a partner at law firm Fried, Frank, Harris, Shriver & Jacobson, notes. But some can be quite onerous. He says requirements range “from some pretty minimal levels of reporting, sometimes even only self-certification, to very, very burdensome covenants” with respect to providing information about the types of investments they can make.
Performance assessment still differs significantly between facilities as well.
“I still think that there is huge variability in how performance is measured,” says Shelley Morrison, head of fund finance at Abrdn.
But she adds that there is a recent change in performance oversight.
“What we are seeing now is a move towards a market expectation that performance is reported and audited by an independent third party,” Morrison says. “That is now becoming the market standard.”
Not all dark clouds
Some say that turmoil in the broader debt markets has naturally affected sub lines, as issuers and lenders struggle with geopolitical and economic uncertainties.
Sub lines in general are still available, but borrowers will pay “slightly higher pricing” and it will take longer before they get lenders that are right for them, says Du.
“The broader environment for subscription finance is still pretty orderly. It just really takes more effort to find the right lender,” she says.
Summers agrees there is a natural decrease in issuance and demand for sub lines more generally in the current environment. “I think in general there’s just a little bit less activity,” he says.
Yet others are experiencing a continued uptick in activity, at least in Europe. Abrdn’s Morrison says the increase has even been more pronounced recently.
“We are continuing to see more demand and supply for ESG-linked sub lines in the market, and particularly over the last 12-18 months.”
But borrowers aren’t coming to the market for the potential savings on interest they can obtain by hitting their ESG targets, sources note. Misson says the discounts are too negligible – as low as five basis points – for it to be a consideration for many borrowers.
Sources are optimistic that demand for the facilities will be strong over time.
Claire Hedley, who is ESG director at 17Capital, says that sponsors can use the sub lines as a way to demonstrate their support for ESG.
“If a firm is committed to their ESG and sustainability strategy and they’re looking for ways to demonstrate that through the investments that they make and the way that the firm operates – then making an ESG link in your subline is appealing.”
Using the facilities can also bring reputational benefits to sponsors, Hedley adds.
“It helps build the narrative around ESG and put that commitment and progress out there for stakeholders to see.”
Du says that the facility is here to stay, pointing to interest in ESG from investors such as sovereign wealth funds and pensions.