Debt tied to carbon emissions may have low financial penalties but can also ding issuers on intangibles like their reputation.
There has been an increased jump in issuance of bonds and loans tied to environmental, social, and governance performance, or ESG, to meet the huge demand from investors for socially responsible investments, the Wall Street Journal reports.
Lenders have long put conditions on ratchet loans or step-ups on bonds that change rates depending on a company’s financial performance. Now, there are more looking into tying interest costs to nonfinancial risks, like reducing carbon emissions or improving governance. Consequently, an investors would get paid more if the companies fail to meet their ESG goals.
While lenders may get a cheaper loan if they meet these ESG targets, Tariq Fancy, who spent almost two years as chief investment officer for sustainable investing at BlackRock, argued that penalties are too small to matter.
“A BlackRock might get a bit of egg on its face if it doesn’t hit its targets, but that’s not going to make any difference to the individual decisions made down in the business,” Fancy told the WSJ. “How is the hiring person going to know, or care, that the finance department makes marginally more or less due to their hiring decision?”
According to 9fin, the penalties and benefits attached to $15 billion in ESG-linked loans since last summer can be as little as 0.025 percentage point of annual interest for each target.
“It’s the reputational risk that comes from missing your target that is much worse” than the interest penalty, Fraser Lundie, head of credit at fund manager Federated Hermes, told the WSJ.
“The fact that you have an economic consequence to a target you’ve set raises the profile of that target, everyone knows it’s there,” Sam Lukaitis, a director in Carlyle’s European financing group, told the WSJ. “I think the economic impact of these will grow over time.”
For more news, information, and strategy, visit the ESG Channel.