Are Green Bonds a COP out? Why loans not bonds are a better format to deliver ESG funding

In this piece I’ll cover why changing the format of ESG lending is a more effective way to deliver on KPIs

Investors have become more discerning in how they lend their money. This started with Green bonds and has grown to include all aspects of ESG. The fixed income market now has dedicated ESG funds with varying levels of acceptance criteria that need to be met before fund managers can allocate capital to certain companies and their securities.

So far so good. So why the punchy headline? What is wrong with the current format of lending? Well, simply put it comes down to accountability. How can investors be sure that the capital they commit now will be deployed in line with their wishes over the next 5 years? If it’s not, wouldn’t it be better to have an element of control over the deployment of that funding?

Using revolving ESG credit facilities loan investors can ensure borrowers are full compliant with the ESG covenants agreed every time they want to draw on capital.

So what’s wrong with ESG bonds? Well with a bond once it is funded the money has left the building, you can’t recall it. Once a Green bond is issued by a company, if it doesn’t fulfil its ESG obligations they face small financial penalties. Coupon increases for ESG breaches are largely immaterial – normally only representing 0.125% in additional borrowing costs. This means, packaging company X who borrows $900mn through a green bond would pay an incremental $1.125m a year if it breach its ESG criteria. Not a lot for a company that making $ billions in EBITDA…  

Practically, in the event a company was not fulfilling its obligations, there is precious little investors can do to prevent access to that capital. Intervention would require investors to call an event of default, starting a lengthy and expensive legal process to recoup whatever money hasn’t already been spent.

Release of capital subject to ESG lending and audit criteria is a much more sensible way to ensure companies or governments are sticking to their commitments.

An ESG Loan however is a much better way to lend to companies. Structured properly a ESG Loan investors can ensure borrowers are full compliant with ESG conditions agreed every time they want to draw on capital. Release of capital subject to ESG lending and audit criteria is a much more sensible way to ensure companies or governments are sticking to their end of the deal. Packaging company X will be full incentivised to hit their targets if suddenly only $600mn instead of $900mn of funding is available.

ESG covenants will soon carry the same weight as financial performance. Deploying capital in the right format where investors have control as well as transparency will ensure the most effective ESG performance and KPI delivery.

LedgerComm provides a customisable borrower interface for ESG and financial reporting direct to lenders. To find out more about how we can help your business then please get in touch.

Will Nash

Will Nash is the Founder of LedgerComm.