The Financial Conduct Authority (FCA) has highlighted a number of issues in sustainable lending which are stymying the growth of the market.
In a letter sent yesterday to sustainability heads at banks, the watchdog noted that the market for sustainability-linked loans (SLLs) – which link borrowing costs to sustainability targets – had “grown rapidly” over the past five years
Although the loans provide useful transition finance alongside other financing instruments, the FCA raised a number of concerns around the market that could hamper its performance.
Andrew Stanfield, banking counsel at Linklaters, said: “Greenwashing risks are right at the top of the agenda. Closer scrutiny of sustainability provisions is the natural consequence.”
Among the concerns were weak incentives, potential conflicts of interest, and suggestions of low ambition and poor design in some SLLs.
A number of firms suggested that standards varied considerably. One firm considered that, of 250 SLL transactions completed in 2022, less than a third were deemed ‘fit for purpose’.
The FCA said there was a strong case for clearer targets and performance indicators to align the interests of borrowers and lenders.
“Market participants that we spoke to believe that a more prescriptive framework would improve market integrity and reduce the threat of greenwashing accusations. This could include more meaningful, science-based targets,” the regulator said.
Conflicts of interest were also observed because in many cases remuneration was linked to achieving ESG targets.
“Stakeholders observed that a number of banks seem keen to promote SLLs,” the FCA noted.
Additionally, banks were often more concerned about the ‘relationship’ with the borrower rather than their sustainability credentials.
Increasing trust and transparency could help deliver wider uptake, the watchdog said.
While the FCA said it has no plans to introduce regulatory standards into the market, it said it will “reconsider” if the market needs it.
However, Richard Gibbard, a senior lawyer at Fieldfisher, said regulators should be wary of bringing in “hard laws” which would bring in greater costs and litigation risks.
“There is a balance to be struck with creating an ESG disclosure, monitoring and reporting landscape that is robust and has integrity and one that doesn’t introduce a disproportionate burden or risk,” he said.
“There is also an inherent conflict of interest in a pricing/KPI-based ESG strategy for two linked reasons: (1) setting KPIs that may provide a windfall for lenders where borrowers fail to meet ESG criteria, this is dubious ethically (2) incentivising borrowers to hit ESG targets by effectively reducing a lender’s profit on a loan does not on the face of it make great business sense for lenders and their shareholders,” he continued.