Our key views:
- The US lags behind the EU in sustainability-linked loan issuance and maturity.
- The market is still immature overall, and a pedagogical approach is still very much needed.
- The EU integrates more SLLs into the credit structure, making them mainstream among banks and private credit.
- Even though federal banks have paused further increases in interest rates, now is the time for US fund managers to integrate SLLs into the credit structure and have financial incentives for sustainable change.
SLL issuance has grown significantly across the global market since their introduction in 2017. In particular, the European, US, and Asian markets have seen this issuance increase, rising from $11bn in 2017 to $877bn in 2022 (BBVA, 2023). Although Europe got off to an early start over the Americas and Asia and has maintained a lead in SLL issuance, the latter regions have an opportunity to close the gap. Unlike the Asian market, which has continued to grow, the US market experienced a significant issuance drop in 2022 and 2023, a result of greenwashing concerns, stringent requirements, the upcoming presidential election, and purportedly limited financial incentives (Bloomberg, 2024; The Banker, 2024). With recent increases in interest rates and an increasing regulatory focus on ESG (ex., SEC), we implore lenders to consider properly structured SLLs as a tool to provide financial and reputational benefits (Norton Rose Fulbright, 2023). As stated by Marieke Boudeling, Principal in our Amsterdam office, "Now is the perfect time for US fund managers to start considering integrating SLLs into their sustainability approach, especially if they are considering fundraising in Europe."
The popularity of SLLs among borrowers surged through 2021, driven by several factors. One of these is the margin reduction, which reduces loan interest if the borrower can achieve their SPTs, thereby helping the borrower save money in the long term (PRI, 2022). SLLs have no specific use for proceeds, allowing access for a wide range of borrowers (Cadwalader, 2023; Norton Rose Fulbright, 2023). As long as a company is willing to adopt a sustainability strategy, there is potential for an SLL (Norton Rose Fulbright, 2023). Additionally, with SLLs come reputational benefits and a signal to stakeholders that the borrower is committed to their sustainability goals (Norton Rose Fulbright, 2023). As with borrowers, SLLs can benefit lenders by aiding their net-zero commitments and facilitating alignment with national and international regulations (Norton Rose Fulbright, 2023; PRI, 2022).
The first SLL agreement was signed in Europe in 2017, and since then, the European market has continued to act as a market leader in SLLs (SPG Global, 2021). In 2022, roughly 50% of leveraged loans in the EU had sustainability-linked clauses, an increase from 44% in 2021, despite a drop in leveraged loan issuance between the years (Reorg, 2023; Debt Explorer, 2023). Additionally, 52% of SLLs issued globally in 2022 were in Europe (Climate Finance Monitor, 2023). In total, $374bn in SLLs were issued across EMEA in 2022 (BBVA, 2023). The Green New Deal, which includes the SFDR, CSRD, and EU Taxonomy, has acted as a driver for SLL issuance in Europe by encouraging sustainable investment through the regulation of fund disclosures (Norton Rose Fulbright, 2023). Issuance has slowed recently in Europe, as SLLs often arise from refinanced loans (Bloomberg, 2023). Many of these loans were refinanced throughout the pandemic and will not need refinancing until 2024-2025 (Bloomberg, 2023). The drop in issuance among European lenders is expected to continue in the near future, giving the US and other markets an opportunity to catch up.
The United States has historically been hesitant when it comes to SLLs. The margin ratchets of SLLs can seem counterintuitive to US LPs, which have a heavy focus on fiduciary duty. However, improvements in sustainability profiles help reduce the risk profile of investments, aligning with the LPs’ fiduciary duties. Despite this hesitancy, the US market began to bridge the issuance gap with the EU up until the drop in 2022 (Debt Explorer, 2023). Although ESG regulations in the US private markets lag behind those in Europe, the capital flexibility provided by SLLs helped grow issuance through 2021 (Cadwalader, 2023). A drop in SLL issuance in the US occurred during 2022 and 2023, amid greenwashing concerns, stringent requirements, the upcoming presidential election, and seemingly insufficient financial incentives (Bloomberg, 2024). Despite this drop (which may continue into 2024, especially with the political climate surrounding the election), we continue to advise the uptake of SLLs heading into 2024. With recently passed (albeit currently pending lawsuits) SEC regulations aimed at standardizing ESG disclosures in the public market, private lenders can maintain pace with ESG in the public market and improve reputation among investors via SLL issuance (EY, 2022). For those fundraising in Europe, where ESG is more stringently regulated, SLLs provide reputational benefits among investors. Additionally, with properly structured SLLs in accordance with the SLLP, greenwashing concerns can be reduced and financial incentives can be improved.
Despite the recent drop in SLL issuance in the US market, with properly structured loans, concerns can be addressed, benefiting both lenders and borrowers.
We advise US fund managers to explore or further integrate SLLs as an instrument for driving ESG performance in their strategies, and we at Holtara are here to guide you through the intricacies of SLLs.
