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US investors herald green shoots in ESG loans

·4 min read

By Aaron Weinman

NEW YORK, July 15 (LPC) - Investors in the US leveraged loan market, urged by stakeholders to ramp up their portfolios with environmental and socially friendly investments, are welcoming the opportunity to grow their exposure to green loans, though obstacles abound.

The interest comes after power plant operator Georgia Renewable Power syndicated the first green deal to institutional investors in the US leveraged loan market last month. Before this transaction, US loans linked to Environmental, Sustainable and Governance (ESG) principles had been raised and held by banks.

Institutional investors are heightening discussions with banks about sustainable finance in a bid to allocate funds to companies dedicated to promoting cleaner energy or implementing inclusive business practices, such as hiring more women and people of color.

"As the loan market evolves, (ESG) is top of mind for a lot of investors. We have also begun proposing, on term sheets, that sponsors have ESG metrics in their deals," said Chris Blum, managing director and head of leveraged finance at BNP Paribas.

Given the novelty of institutional ESG-linked loans, however, bankers pitching green loans cannot yet determine if there is a pricing advantage that would lower funding costs for their clients. Until there's a critical mass of green-linked transactions, investors are also unable to assess the level of risk in not meeting ESG standards.

"Pricing in the pro rata loan market relies on historical information like default rates," said Blum. "These deals are still largely determined by internal risk-weighting models, not climate and sustainability risk. We hope to see that change in the future."

Nonetheless, investors are being urged by their stakeholders to ramp up their portfolios with ESG-linked investments now. Whether through green bonds or loans, the pressure is mounting on corporations to be viewed as valuable corporate citizens.

"Each company's approach to this is unique, but ESG is a core concept of components when you go through the analysis of a company," said Rusty Wiley, chief executive officer at Datasite, a software services provider that tracks the life cycle of mergers and acquisitions. "Our data rooms are getting larger and when you look at diligence processes, companies have another pillar to meet in terms of ESG."

TRICKLE-DOWN EFFECT

In February, trade group the Loan Syndications and Trading Association (LSTA) took initial steps to introduce green finance into the US leveraged loan market with an ESG questionnaire.

Seen as an ideal starting point for US leveraged companies, the survey helps determine if borrowers have a formal ESG policy in place and asks businesses if they adhere to green frameworks such as the Sustainability Accounting Standards Board (SASB). SASB has developed accounting standards for lenders and investors to help monitor companies’ ESG factors through standardized reporting.

Several companies have completed the questionnaire and applied it to potential transactions, according to Tess Virmani, an executive vice president at the LSTA. The approach has ramped-up dialog between investors and borrowers, and encouraged transparent, standardized information that can be broadly adopted by the US leveraged loan market.

"The questionnaire is in response to asset managers who are required to answer to their end investors on ESG matters. It's important they have reliable information, which will support the development of ESG-related debt products," said Virmani.

This push for transparency may also help identify a viable price and risk premium for green loans, according to Anne van Riel, the co-head of sustainable finance capital markets at BNP Paribas.

"Pricing is supposed to be a reflection of risk. When there is more information available about how climate change and social risk can impact the bottom line of an issuer, that gets added to financial models and reflected in pricing," she said.

Large corporations, including Italian utility Enel and Danish shipping giant AP Moller-Maersk, have raised billions of euros and US dollars in green-linked loans from banks. And while market participants believe transferring this momentum into the leveraged universe will be more a marathon than a sprint, several are confident that the appropriate seeds have been sown to grow this nascent area.

"It started with investment grade, but that trickles down to other markets next," added van Riel. (Reporting by Aaron Weinman. Editing by Michelle Sierra and Kristen Haunss.)