Banking & Finance aspects of ESG

The potential impact of ESG factors on long-term sustainability and profitability is increasingly recognized. This will make ESG an aspect that our clients in the Banking & Finance industry, notably financial institutions, lenders, and borrowers will have to give serious consideration.

For borrowers, incorporating ESG considerations into their operations can help them mitigate risks and enhance their reputation, making them more attractive to lenders. Borrowers with strong ESG credentials (A) may have easier access to capital, (B) may have access to cheaper capital and (C) may be viewed more positively by investors, customers, and other stakeholders. Each of these could enhance the borrower's reputation and competitive advantages.

Lenders also increasingly incorporate ESG factors into their lending decisions, as they recognize the potential impact of these factors on borrowers' long-term financial performance. By lending to borrowers with strong ESG credentials, lenders can reduce their exposure to risks related to climate change, social issues, and governance failures.

Regulators more and more emphasize the importance of ESG in financial institutions' decision-making processes. For example, the European Union's Sustainable Finance Disclosure Regulation (SFDR) requires financial institutions to disclose how they integrate ESG factors into their investment decisions. Moreover, already in June 2020 the Dutch Authority for the Financial Markets (AFM) published a position paper on the important role of the financial sector in the transition to a more sustainable society.

Cees-Frans Greeven

Partner | Lawyer
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Innovating financial products

The incorporation of ESG considerations into finance has led to the development of new financial products, such as green bonds and sustainability-linked loans, which offer lenders new opportunities to finance sustainable projects and encourage borrowers to improve their sustainability performance.

Green bonds are debt instruments issued by companies or governments to finance environmentally sustainable projects. The proceeds from green bonds are earmarked for specific projects, such as renewable energy projects, energy-efficient buildings, or sustainable transportation. The bond issuers typically provide investors with reports detailing the environmental impact of the projects financed by the bonds.

In contrast, sustainability-linked loans are loans that are linked to a company's sustainability performance. The loan's interest rate is tied to the company's ability to achieve pre-agreed sustainability targets, such as reducing greenhouse gas emissions or increasing the use of renewable energy. If the company achieves its sustainability targets, the loan's interest rate may be lowered, while if it fails to meet its targets, the interest rate may be increased.

Finance documentation

Finance documentation and standards have been developed to address ESG in financing transactions. Loan Market Association-type financing documentation may include:

Green Loan Principles for the financing of green projects, with the principles defining the characteristics of green loans, such as the use of proceeds, the management of proceeds, and the reporting of environmental benefits;

Sustainability Linked Loan Principles, which provide a framework for the issue of loans that encourage borrowers to improve their sustainability performance. The characteristics may include the setting of sustainability performance targets and the reporting of progress towards those targets;

Social Loan Principles, aimed to develop a framework within which new ‘social loan’ products will be created. Rather than environmental change like Green Loans, social projects aim at bettering society through applications such as affordable infrastructure, essential services, affordable housing or food security; and

ESG clauses that require borrowers commit to meeting certain ESG targets and lenders to monitor the borrowers’ progress towards those targets.

Investment Funds

Focus increasingly lies on ESG principles-based sustainable investing. European Union rules related to ESG apply to managers of alternative investment funds (AIFMs), undertakings for collective investment in transferable securities (UCITS), investment firms licensed under the MiFID II regulation and on the alternative investment funds and UCITS under their management.

In 2018, the European Commission identified two main factors for ESG, i.e. (i) improving the contribution of finance to sustainable and inclusive growth and reducing the impact of climate change; and (ii) strengthening the financial stability by incorporating ESG factors into the investment decision-making process.

A sustainable investment fund has a portfolio of equity or bonds, for which ESG factors have been integrated into the investment process. This means the fund’s equity and bonds have passed stringent tests on respective ESG criteria.

Would you like to know more about the impact of ESG to your financing arrangement? Would you like to learn more about what ESG could mean for your business and how BUREN can assist you in developing and implementing a successful ESG strategy? Please do not hesitate to reach out to us.

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