A new wave of “green lending” has hit Canada, with Bank of Montreal issuing the country’s first sustainability-linked loan to Maple Leaf Foods.
Under $2-billion worth of credit facilities issued by BMO, Maple Leaf Foods has the potential to lower its interest rate by hitting targets for matters such as electricity use, water use and carbon emissions reductions. Credit facilities traditionally have a fixed interest rate.
The structure marks an evolution in the market for sustainable debt. For more than a decade, “green bonds” have been the hot ticket, helping issuers raise money from public investors at discounted rates, so long as the proceeds were put toward specific types of “green investments.”
But as this market proliferated, there were worries the green label was too often slapped on what would otherwise be normal debt. In other words, it could be a marketing ploy. Sustainability-linked loans, meanwhile, have prespecified targets and the potential for interest rate reductions, providing the borrowers with incentives to meet green goals.
Globally, the first sustainability-linked loan was issued in 2017 and the structure is starting to catch on in Europe and the United States. While green bonds still account for 77 per cent of all sustainable debt issued, according to Bloomberg NEF, sustainability-linked loans now comprise 10 per cent of the global market.
While these loans seem to benefit the borrowers – because they can lower the interest rates they pay – the banks that underwrite the credit facilities can also gain. Shareholders increasingly want to see commitments to environmental, social and governance (ESG) principles, with 70 per cent of participants in Royal Bank of Canada’s 2019 responsible investing survey saying they use these principles for their investment approach and decision making.
To this end, BMO refined its enterprise goals this year, and one of its major initiatives is to support a sustainable future – for clients, for itself and for Canada. In July the bank appointed Jonathan Hackett as its head of sustainable finance.
Sustainability targets can also push borrowers to invest in new, more efficient machinery and facilities, and also nudge them to prepare for a lower-carbon future. After doing so, “investors will give them more capital," Mr. Hackett said, and the efforts can also improve their credit risks.
“Some empirical data suggests there may be a link between strong performance on ESG factors and improved corporate financial performance and investment returns," credit rating agency Standard & Poor’s wrote in a September report.
"Although much more research needs to be done in this area, we believe independent and consistent analysis of ESG metrics can help anticipate potential financial risks and opportunities in the longer term, such as evolving environmental regulations and disruptive technological advancements.”
The lingering question, however, is how committed borrowers will be to achieving their sustainability goals. If the targets aren’t met, the lending wave may not change much – which is what happened with green bonds.
“Green bonds were a really good way of green-washing," said Ryan Riordan, director of research at Queen’s University’s Institute for Sustainable Finance, which involved "taking a bunch of assets you already had and financing them at lower rates.”
For sustainability-linked loans to make a difference, he believes there needs to be objective monitoring. “You need an independent body to see if they achieve these goals," he said.
At the moment, a small number of firms such as Sustainalytics and Vigeo Eiris do this type of work.
Another option is for underwriters to impose penalties for failing to meet the targets. In July, Spanish telecom company Masmovil took out a sustainability-linked loan and the interest rate was tied to an overall ESG evaluation score. If the score improves, the interest rate drops by 15 basis points – or 0.15 percentage points – but if it deteriorates, the interest rate increases by 15 basis points.
BMO’s Mr. Hackett said the bank is not using an outside group to measure Maple Leaf’s sustainability success, and company’s interest rate will not rise if the targets aren’t met.