Market Insights 

Sustainability Linked Loans and Securitised Mortgages: Striking Similarities and Sobering Lessons

Sustainability-linked loans (SLLs) are financial tools incentivising borrowers to meet predetermined sustainability performance targets. Interest rates on these loans vary based on the achievement of these targets, which are tied to environmental, social, and governance (ESG) criteria. They encourage companies to improve their sustainability performance, thereby helping finance their transition to greener business models.

In the financial world, sustainability-linked loans (SLLs) have been a game-changer, enabling borrowers to signal their ESG commitments and providing lenders with downside protection as well as incentives from regulatory and governmental entities. However, the rising regulations around these loans are posing considerable challenges. Until recently, SLLs have largely gone unregulated with little to no official government oversight. What has resulted is an industry that remains opaque and lacks transparency.

Beneath the Green Veil: Unpacking the Regulatory Challenges of Sustainability Linked Loans

SLLs have grown exponentially in recent years, much like the securitised mortgage market in the late 1990s and early 2000s. Both instruments promised significant societal benefits: while mortgages facilitated home ownership, SLLs aim to support sustainability initiatives. However, like mortgages that faced regulatory scrutiny following the 2008 crisis, SLLs too are now under the regulatory lens due to growing concerns about greenwashing and potential integrity risks.

The Financial Conduct Authority (FCA) has already flagged potential issues in its market review of the SLL sector [1]. The review highlighted that despite their role in transitioning to a more sustainable economy, these loans have often been marred by weak incentives, potential conflicts of interest, and poorly designed Sustainable Performance Targets (SPTs) and Key Performance Indicators (KPIs).

The Challenge: Setting and Tracking SLL KPIs

SLLs have two core challenges: setting appropriate KPIs and accurately tracking these KPIs. The former involves defining quantifiable, ambitious, and realistic targets aligned with the borrower’s sustainability strategy. The latter requires meticulous monitoring and reporting to ensure transparency and avoid greenwashing allegations.

The FCA report indicated that out of 250 SLL transactions in 2022, only 30% were deemed 'fit for purpose', and in 50% of cases, KPIs were not robust [2]. Evidently, setting and tracking appropriate KPIs is a critical aspect that many players in the SLL market are struggling with.

A platform that streamlines SLL reporting and tracks KPIs

The challenges posed by SLLs demand innovative solutions. A key part of this puzzle is having robust tools that allow borrowers and lenders to track KPIs in real-time and in a way that is automated. Radiant focuses on collecting asset-level data that is accurate and reliable, protecting lenders against misreporting data. Radiant also provides a quick way to understand the impact your loans are having on your SLL portfolio. 

Image 1 - A snapshot of Radiant's software tracking borrower KPIs

We’ve been surprised to see how few banks understand the true impact that their lending activity is having on the borrowers they’ve lent money to. With our streamlined data collection process, you can efficiently monitor targets and loan performance. This leaves analysts and reporting teams to focus on higher-value activities. 

The Road Ahead

While SLLs are becoming increasingly important in the financial ecosystem, the rising regulations around them cannot be overlooked. Regulatory bodies worldwide are stressing the need for transparency, precise tracking of KPIs, and robust SPTs to maintain market integrity and prevent greenwashing.Our platform offers a robust solution that not only addresses these regulatory concerns but also provides a competitive advantage. By leveraging our platform, financial institutions can automate, scale, and streamline their SLL process, accurately track lending impact, and avoid misreporting and misrepresentation of data.

Image 2 - A snapshot of Radiant's impact tracking capabilities

In the end, the goal is not merely to comply with regulations but to turn compliance into a competitive advantage. Our platform enables financial institutions to build trust through transparency and inspire change in the market. This way, you not only safeguard your profits and credibility but also play an instrumental role in driving the green revolution.

Sources:

[1] FCA Market Review, "Sustainability-Linked Loans Market", 2023 

[2] FCA Review Findings, 2023

Contact: jon@getradiant.ai

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