Sustainability-linked financing must have clearly defined goals

In sustainable finance, tallying the present situation is less relevant than understanding where the companies should be heading and how we can measure and encourage this progress.

In the last three years, banks have started offering various sustainability-linked loans to large corporations. By taking out this type of a loan, the company commits to specific sustainability-related goals, and the loan margin is adjusted on the basis of indicators related to these goals. In other words, the bank will make the loan cheaper if the company acts in a way that can be expected to reduce its counterparty risk, especially in the long term. This can benefit both the bank and the borrower, but choosing the right indicator is important.

We have the right idea with these loans, but we don’t yet have a good consensus on what the metrics and indicators should be. For example the Guidance on Sustainability Linked Loan Principles, published by the Loan Market Association, aims to define them better.

Various actors in the market already publish classifications or grades that depend on sustainability. Investors often rely on these grades in their decisions, so they indirectly influence the values of public companies’ debt instruments. These actors are not yet regulated or supervised, however, and the estimated values of potential investments can therefore be solely based on publicly available information, which is not always comprehensive. Some of these assessments may even have been made without consulting the target company. The sustainability classifications and grades should therefore be taken with a grain of salt, at least for now.

For banks, it is essential that the indicators are tied to aspects of responsibility with financial relevance. Because every company should already be expected to be on par in terms of ethical criteria, it may be easiest to find useful measurable criteria from among environmental considerations. Companies might not be able to tell which aspects of responsibility carry the most financial significance, however. In that case, it may easiest to choose an existing certificate which can verify the company’s performance in a specific area of sustainability.

Financially significant sustainability indicators are usually well aligned with the goals of the company that is considered for investment. But selecting ambitious goals in which the emission cuts are not tied to production or efficiency, for example, takes courage from the company and discipline from the banks. This can be difficult or even impossible to achieve in some sectors and is very challenging especially for fast-growing companies.

This column is part of a series where Finance Finland member companies talk about responsibility in the financial sector.