Report on Sustainability-Linked Loan Market
The Financial Conduct Authority (FCA) has released a report on Sustainability-Linked Loan Market (SLL) report aimed at understanding the current state of the SLL market and promoting the development of this transitional financial instrument.
The FCA believes that in order to achieve the promise of a net zero economy by 2050, sustainable finance will become the focus of future development, and SLL will play an essential role as a sustainable tool in the financial market. Although the FCA does not directly regulate the SLL market, conducting detailed investigation and analysis of the SLL market can ensure the good operation of sustainable financial markets, support sustainable risk management for enterprises, and maintain market fairness. FCA publishes the Report on Sustainability-Linked Loan market to summarize its findings.
Current Situation of Sustainability-Linked Loan Market
The FCA engages stakeholders in the sustainable linked loan market to collect relevant information and understand in what areas it can encourage the development of the SLL market. In the past five years, the SLL market has developed rapidly, but there are also some issues that need to be modified.
As core participants in the SLL market, banks typically include these loans in their sustainable financing goals. However, there are significant differences in the classification of SLL by banks, with 50% of banks not being sound in terms of key indicators. Out of 250 SLL loans last year, only 30% were considered to meet sustainability standards.
Two Potential Risks in the SLL Market
FCA believes that there are two risks in the report on Sustainability-Linked Loan market. On the one hand, SLL has greenwashing risks, and the market lacks trust in these financial products. On the other hand, borrowers are merely affected by interest expense in SLL and are disturbed by the supervision, which challenges the issuance motivation.
In terms of greenwashing risk, the borrower needs to disclose the transition plan involved in SLL and combine it with key performance indicator. The Transition Plan Taskforce (TPT), in which FCA participates, can provide a framework for these transition plans to enhance issuers’ sustainable disclosure.
In addition, issuers can also maintain consistency with international sustainable disclosure standards, such as the Climate Transition Finance Handbook published by International Capital Market Association (ICMA), which recommends issuers to use relevant international standards to raise funds.
Related Post: ICMA Releases a Report on Sustainability Linked Bond
In terms of issuance motivation, issuers need to collaborate with lenders or sustainability advisors, and there is a certain gap in the time and capital costs compared to the profits saved by issuing SLLs. In the absence of meeting performance indicators, the actual increase in interest rates is very small. For high rated loans, the spread is between 2.5 and 5 basis points, while for low rated loans, the spread is between 5 and 30 basis points.
Despite the development of the SLL market and the continuous increase in global interest rate levels, the increase in interest rates for these SLLs has not changed much. In this situation, whether the issuer has sufficient motivation to complete the incentive targets, or whether it has sufficient motivation to avoid interest rate increases, remains a key factor limiting the development of the SLL market.
FCA believes that banks’ pursuit of sustainable financial goals may accelerate the approval of SLL. In this case, some underperforming SLLs may also be passed, although they may not meet the established incentive targets, but will become remuneration linked indicators for banks in sustainable financial activities.
FCA’s Future Plans for the SLL Market
FCA plans to seek market feedback to strengthen trust and transparency in sustainable financial instruments, and encourage the industry to revise the Sustainability Linked Loan Principles (SLLP) to support SLL market.
FCA also plans to continue monitoring the SLL market as part of its transitional financial work and consider whether to take other measures to regulate the transitional financial system in the future.
Reference:
FCA Outlines Concerns about Sustainability-linked Loans Market
