Ratcheting regulatory interest in sustainability-linked loans

06 July 2023

The Financial Conduct Authority (FCA) has made clear its concerns regarding the "greenwashing" potential of sustainability-linked loans (SLLs). It is perhaps unsurprising that regulatory interest in SLLs has – in conjunction with the desire for consensus in how to document them (Sustainable drafting for sustainability-linked loans?) – grown with the popularity of the product.

We previously identified the FCA’s interest in SLLs as part of an increasing regulatory focus on greenwashing in both the EU and UK: Greenwashing: now defined, and upcoming regulatory enhancements. The FCA’s engagement with SLL market participants has, for now, culminated in a letter being sent to bank Heads of ESG/Sustainable Finance and published on the FCA website. The FCA acknowledges that it does not directly regulate the SLL market (which in itself makes this a noteworthy intervention), but is “keen to ensure that the sustainable finance market works well, and that market integrity is maintained”. Consequently, whilst the letter is most squarely directed at banks, FCA-regulated credit fund managers and other lenders active in this area should take note of it being published “so that all interested parties active in the SLL market can reflect on its content, whilst drawing attention to a number of observations and weaknesses in the market that were identified”. Key among these is the potential for conflicts of interest if lenders accept weak sustainability performance targets for a borrower and count the SLL as part of their sustainable finance quota.

By expressly approving the Sustainability-Linked Loan Principles (SLLPs) as embedding good practice, the FCA incidentally highlights the distinction drawn between SLLs which meet all of the components of the (voluntary) SLLPs and those which do not. The latter might avoid the SLL label and be called ‘ESG-linked loans’ or similar, which speaks to the importance of communications and publicity surrounding lenders’ and borrowers’ sustainability credentials – the requirements of the sustainable financing they enter into must not be represented as being more rigorous than they are. The FCA’s findings and comments should prompt even more conscious and careful:

  1. analysis of loan terms with reference to the SLLPs; and 
  2. consideration of the appropriateness of surrounding communications.

With credit to the Loan Market Association (LMA) (and the Loan Syndications & Trading Association (LSTA) and Asia Pacific Loan Market Association (APLMA), with which the LMA teams in crafting the SLLPs and principles for other sustainable lending products), the importance of maintaining (building?) sufficient trust and integrity in the SLL product for it to have the hoped for environmental, social and/or governance impacts had already become a first order issue for many.

It is now clear that this includes regulators. The FCA says that it will continue to monitor the SLL market “as part of our wider work on transition finance, with a view to considering the need for further measures to support the development of a robust transition finance ecosystem”. It is worth noting the description of SLLs as “transition finance” – as a tool to incentivise sustainable business practices, they are indeed better suited to borrowers which are in the early stages of their transition journey (to use the phraseology of the guidance on the SLLPs) than those which have a relatively long-established record of improvements in sustainable performance and commensurately less road to run. However, more significant in this statement is the potential for “further measures”, with the FCA willing to introduce regulatory standards or a code of conduct if the market needs it. It is interesting to consider how this harder action might be implemented, and whether there are even rough precedents for it in the private market for loans (other than those made to consumers).

Perhaps as a result of the timing of the letter (it was sent on 29 June, a day before the final publication of LIBOR as we have known it), minds turn to the FCA’s marshalling of the transition from LIBOR and its expectations as to the conduct of lenders. These were positioned on a broad basis, somewhat regardless of the regulatory oversight that could be applied to the LIBOR-referencing product (rather than lender entity) involved. There may be something of a developing parallel in the FCA’s approach to SLLs.

The transition from LIBOR may come to be considered a success for the part played by the FCA. The grander (particularly climate) ambitions of transition finance will require dedicated focus on its fundamentals over a much longer timeframe for it to be impactful. It appears the FCA, along with regulators in other jurisdictions, will not sit on the side lines.

'We want to build trust and integrity in these products. We hope all market participants will consider carefully today’s findings as well as the existing principles published by the Loan Market Association.'