The UK’s Financial Conduct Authority is probing the market for sustainable loans, following concerns that the environmental targets in such deals are too easy for companies to meet.
The watchdog has started interviewing bankers and borrowers about loans that potentially reward borrowers with lower rates but fail to have a significant environmental impact. It is considering whether to bring in a voluntary code of conduct that would set out best practices for loan design.
The FCA, whose probe has not previously been reported, is responding to growing industry concerns about the potential for so-called greenwashing, in which banks overstate their positive social and environmental impact to burnish their reputation.
Last year $29.2bn of sustainability-linked loans were issued in the UK, after raising $34.7bn in 2022, according to data provider Dealogic, amid a broader market downturn. The total amounted to just over a tenth of the European total.
Companies that take out sustainability-linked loans are punished with higher interest rates on their payments if they fail to meet their agreed goals. If they succeed, they are rewarded with lower rates.
“People are selling loans, but maybe not doing it as well as they could do with standards and transparency,” Sacha Sadan, director of Environmental, Social and Governance at the FCA told the Financial Times. “The big worry is that we just don’t end up getting towards net zero even though we’re saying we are,” he added.
Such deals have become increasingly popular among borrowers as they respond to pressure from investors and staff on environmental, social and governance issues.
A particular concern of the FCA is that companies use undisclosed targets for their sustainable loans that may be easier to meet than other corporate targets that are usually made public. “To me the metrics should be similar ones to [those] the boss gets linked on,” Sadan said.
ING, the Dutch bank, recently had to turn away an “important” client that tried to add a low-quality sustainability clause to a loan ING had pitched to co-ordinate, Jacomijn Vels, the bank’s global head of sustainable finance, told the FT. “We’re still very much in this process of becoming a mature market,” she said.
Vels added that so-called “sleeping” sustainability-linked loans, where the goals are not added until after the deal has been agreed, are increasingly common.
ING has some “sleeping” loans on its books but does not count them towards its own annual green financing target of €125bn by 2025 until the clause has been added, known as “waking up” the loan.
“The banks have all made these net zero commitments, so they need to frankly clean up their loan books . . . they are in promotion mode,” said David Milligan, partner at law firm Norton Rose Fulbright. Sustainability clauses are “one of the first questions” bankers ask when striking a loan deal, and are considered a “default option”, he added.
The FCA is also considering whether to ask issuers of sustainability-linked bonds to explain in investor materials how targets fit into the company’s wider strategy.
The regulator said it had “concerns” that issuers were omitting key information from prospectuses, which could be “harmful” and lead to “misunderstanding”, it said in a consultation paper earlier this month.