Sustainable finance is not currently the hot topic it was a couple of years ago. Challenging economic conditions have led firms to prioritise other issues, and there have been concerns around greenwashing.
But businesses should not be lulled into a false sense of security. The forces driven by environmental, social and governance (ESG) issues that influence lenders to become increasingly selective over which borrowers they support, and at what price, are not going away and will only ramp up over time.
The sustainability footprint and emissions profile of a borrower directly impacts on a lender’s own sustainability credentials. Businesses need to ensure they develop a sustainability strategy backed by good-quality data and clearly communicate it to their lenders – or, over time, risk a lender withdrawing their support.
Businesses that don’t have a roadmap in place to improve their ESG credentials may find it negatively impacts their options as soon as their next financing round
Earlier this year, Grant Thornton surveyed nearly 50 UK-based lenders to understand their attitude and strategy towards ESG and sustainable finance for mid-sized firms.
When we last conducted this survey, in 2022, momentum around the ESG agenda was building for the mid-market, driven by lenders’ own sustainability targets and disclosures, and their desire to reduce the emissions produced by their mid-market borrowers.
Since then, against a backdrop of inflation, higher interest rates and geopolitical instability, there has been a hiatus in this momentum across the board. Global sustainability linked loan (SLL) issuance fell 55% in 2023, amid concerns about greenwashing and regulatory uncertainty.
Many businesses also have concerns around the availability of reliable data and the cost of setting up SLLs. This is coupled with more scrutiny from lenders (around the ESG credentials of the borrower, as well as the parameters of any ESG-based loan) as they seek to demonstrate that the sustainable finance they issue is robust and credible.
Nevertheless, our 2024 survey results show that demand is on the rise: 84% of lenders believe that demand for ESG-related lending in the mid-market will increase in the next three to five years. Sustainable finance products act as facilitators to change the behaviour and sustainability credentials of borrowers. They’re also inextricably linked with a lender’s own sustainability ambitions. Businesses that don’t have a roadmap in place to improve their ESG credentials may find it negatively impacts their options as soon as their next financing round.
A mid-market borrower’s ESG status continues to be an important part of a lender’s due diligence: 54% of lenders said that a business’s ESG status and/or its ability to transition to net always or most of the time. And 71% said that (all other things being equal) they are more likely to agree a loan for a business with strong sustainability credentials.
Virtually every large bank has made a commitment for their balance sheet to be net zero by 2050. Some have gone further and have ambitious targets for reducing the carbon emissions they finance by 2030.
The pressure on lenders globally to publish their transition plans and greenhouse gas emissions is steadily increasing. Many UK lenders already voluntarily publish this information, but this may soon become mandatory. The FCA is expected to consult in 2025 on proposals for listed companies in the UK to report in line with the ISSB’s global sustainability disclosure standards (published in June 2023). Final rules on mandatory disclosures for listed issuers may be in place by the end of 2025, potentially taking effect as early as 1 January 2026.
It’s vital that mid-market borrowers understand that their ESG credentials feed into a lender’s credit decision-making. While no-one is expecting overnight change, firms need to develop their sustainability journey, and be able to effectively communicate that with stakeholders. Nearly all of our survey respondents (93%) believe regulators may introduce a requirement to integrate sustainability considerations into a bank’s internal capital allocation models for loans.
This is a crucial point for borrowers to understand. As soon as lenders are required to allocate a greater amount of capital for a loan to a mid-market firm with poor ESG credentials, lenders are likely to have to charge more for such loans or may choose not to make the loan at all.
Despite the headwinds around ESG over the past couple of years, the direction of travel remains the same
In June 2023, the FCA conducted a review of the SLL market amid concerns that it wasn’t working as intended. It found issues of credibility, where sustainability performance targets (SPTs) aren’t robust enough and don’t stretch the borrower to enact meaningful changes in behaviour. Key performance indicators (KPIs), which track performance against the targets, can also be too weak.
Our survey responses illustrate how the market is responding to these concerns:
ESG assurance throughout the life of the transaction is also becoming an important part of the market, with 67% of lenders requiring, or sometimes requiring third-party validation of performance to SPTs/KPIs.
There are a wide variety of lenders who serve the mid-market, from big retail banks and challenger banks to debt funds and asset-based loans. Each lender will be at a different stage of their own sustainability journey, with the large retail banks leading the way in terms of transition planning and emissions disclosures.
Many non-bank lenders currently place less emphasis on sustainability, although some limited partners (LPs) will be driving change in the private credit market, particularly as many LPs are also shareholders in major banks across the world. Despite the headwinds around ESG over the past couple of years, the direction of travel remains the same. Lenders are increasingly looking for mid-market firms to commit to ESG targets. Access to capital and the cost of that capital is likely to become increasingly dependent on this.
Jon Bramwell is a debt advisory director at Grant Thornton
