PRIMER: green loans in Asia

Author: Karry Lai | Published: 18 Apr 2018
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What are green loans?

Green loans allow companies to finance initiatives that have environmental benefits. Some innovative green loan deals in Asia include Wilmar and ING’s $150 million bilateral revolving loan and New World Development’s $459 million hybrid green bond/loan facility. While green bonds have taken off in recent years, their loan counterparts are still at a nascent stage of development. But the financial community sees the potential for green loans to develop as momentum builds for environmentally sustainable projects in various industries.

Where’s the demand for green loans coming from?

There is increasing pressure on companies to report on their environmental impact. Paul Davies, partner at Latham & Watkins observes that this has taken the form of government policy such as the Task Force on Climate Related Financial Disclosures (TCFD) recommendations and from investors, in the form of shareholder legal action. Another example of increased attention to companies’ environmental impact are trackers on environment, social and governance (ESG) disclosures, such as Institutional Shareholder Services’ E&S QualityScore, which tracks the quality of companies’ ESG disclosures and includes hundreds of factors. 

Financial institutions have demonstrated their growing commitment to becoming greener, in particular, by investing in more green assets such as alternative energy companies. 

"The banks themselves are playing an important role in developing the green loan market, while the Portfolio Decarbonization Coalition is an example of a multi-stakeholder initiative which promotes the reduction of greenhouse gas emissions by engaging nearly 30 international, institutional investors with over $3 trillion in assets," said Davies.

For borrowers, green loans give them the extra edge in showcasing their involvement in sustainability.

"Green loans provide borrowers with tangible credentials that they can share with shareholders and other stakeholders to demonstrate a commitment to sustainability...It's effectively a stamp of approval"

"Green loans provide borrowers with tangible credentials that they can share with shareholders and other stakeholders to demonstrate a commitment to sustainability," said Andrew Ashman, head of loan syndication at Barclays. "It’s effectively a stamp of approval."

The demand and supply for green loans can be seen from both borrowers and lenders. "While green bonds have taken off, not all borrowers and not all financings are appropriate for bonds because the bond market likes large, liquid quantums that require sufficient earnings to service," said Latham & Watkins’ Aaron Franklin. "From a lender’s perspective, they are similarly looking to arrange and lend sustainable finance. Sometimes this is because the lender itself has raised green bond finance and is looking for borrowers to fulfill their own obligations."

What areas of improvements are there for green loans?

While green bonds have taken off, more work needs to be done on green loans. The Asian Pacific Loan Market Association (APLMA) has launched the Green Loans Principles to provide a consistent and standardised framework for green loans across the region and will be key to building the green loan market.

Andrew Hutchins, partner at Clifford Chance, explains that the green loan principles focus on use of proceeds, project evaluation and selection, management of proceeds and reporting. "The development of the green loan principles should ensure more transparency and green compliance, leading to less scope for greenwashing of loan financings and loan documentation will continue to develop to reflect the developments in the green loan sector," he said. 

According to  Anna-Marie Slot, partner at Ashurst, the Green Loan Principles provide a clear set of criteria on what green means so that lenders and borrowers can assess their projects against it. "Unless money is being lent to an entirely green entity, there is a challenge in defining what green means and how the proceeds are used," she said.

Green bonds operate through the public disclosure. Issuers tell the market what they will do with the proceeds and investors trust that an issuer will honour that promise, backed up by anti-fraud laws applicable to securities transactions. "By contrast, loans do not necessarily involve public disclosure. It remains to be seen whether this means that the market practice will be to make green promises about use of proceeds part of the loan’s contractual documentation," said Franklin.

Two key instruments have been created in the green loan market to increase incentives. One concept, which was pioneered by ING, is a sustainability improvement loan. Herry Cho, the company's head of sustainable finance for Asia Pacific, explains that it links the interest rate of a general corporate purpose loan to the sustainability performance of borrowers across the environmental, social and governance aspects. If the pre-set sustainability improvement targets are achieved, the interest rate on the facility will be subsequently reduced. 

Another concept is the green use of proceeds loan. These are loans where proceeds are dedicated to a pre-defined eligible green assets or projects. 

"On the back of the Green Loans Principles, we are already seeing increased interest in green loans," said Cho. Measures that improve the risk-return profile of sustainable borrowers, or bring down the cost of funding can also help. For example, ING has teamed up with EIB to €300 million ($371 million approximately) to finance green shipping under advantageous financial terms.

How can green loans be more mainstream?

An effort from the financial industry itself will improve the system and ultimately make green loans more mainstream. "This can be done by increased reporting from banks and will help streamline the system internationally," said Davies. "The TCFD is a good example of how the industry can achieve consistent reporting once everyone is given some guidance on how to carry this out."

GreenDavies adds that SMEs are well positioned to take out green loans due to their versatility and size. Their borrowing will represent an important driver in the development of the green loan market. Green loans are likely to play a significant role in helping countries meet their targets under the Paris Agreement.

"Sectors such as renewables, including wind and solar, across China and India are the low hanging fruit that will be interested in green loans. In the longer term, how other industries that are not traditionally known for being green and how they capture green opportunities will be interesting to watch," said Slot.

A number of factors could influence the future uptake of green loans, including tax incentives and pricing. 

"At this stage, there is no separate pool of liquidity for green loans, but that will be the next development that will spur growth," said Ashman. He adds that from a regulator’s perspective, incentives such as a reduction in withholding tax could help to accelerate the development of the green loan market.

"We are seeing loan transactions contain ratcheting margins based on green covenant compliance, so one of the incentives for green loans for a particular borrower can be reducing pricing, although for borrowers new to the green loan or green bond space, green loans may come with new additional burdens associated with the required additional monitoring, reporting and segregated bank accounts," said Hutchins.

See also

DEAL: world’s first sovereign green sukuk

DEAL: ICBC’s Belt and Road climate bond