Sustainable finance is once again faced with the challenge of greenwashing risks as the sustainability-linked loans (SLL) market begins to cool. SLLs were first introduced in 2017 and have since grown into a $1.5 trillion market. SLLs are designed to tie loans to environmental or social metrics, which is often useful for publicity and marketing from a borrower and lender standpoint. However, the SLL market is largely unregulated globally. Now that regulators and the public are beginning to scrutinize SLLs, some lenders are looking for the door.
A recent article from Bloomberg examines how lenders are looking to add reclassification clauses to their SLL agreements. These clauses would allow lenders to reclassify a loan if it is discovered to not meet sustainability criteria without violating covenants in toto. The article states:
“Greg Brown, a London-based partner in Allen & Overy’s banking practice, says he’s seen a surge in clients asking for new legal clauses in SLL documentation. Such add-ons are designed to let lenders strip the ‘sustainability’ element from a loan. So-called declassification provisions mean bankers can just book what had been an SLL as a normal loan, should they subsequently realize the product doesn’t actually merit an environmental, social or governance label.”
According to the article, this desire to add reclassification clauses comes as many SLLs are coming up for renewal in 2024. The article also predicts that SLL markets will fall from their peaks seen in 2021 and 2022, partly due to increased scrutiny from regulators.
While banks backing off of SLLs could be seen as a failure to grow sustainable lending, it is probably more a reflection of the natural cycles associated with ESG. Often, we see new products claiming ESG credentials get a lot of attention and grow quickly before being culled by regulators. Fewer SLLs in 2024 may mean less sustainable lending overall because lower-quality SLLs would be rejected or reclassified. Companies with sustainability targets tied to SLLs may face challenges if the overall SLL market shrinks as a result of rejection or reclassification. Additionally, issuers will be unable to capitalize on the publicity and marketing benefits that reclassified SLLs once provided.
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