Are your net zero commitments sufficient for successfully refinancing your business loans and achieving growth? Claire Martin and Amy Hamilton share their guidance on making the right decisions.

As refinances come around or you seek additional debt to bolster your growth prospects in the coming months, keeping ESG lending conditionality front of mind will be vital to avoid unexpected issues accessing funding and the associated consequences.

Net zero lending conditionality for the mid-market

Some banks, such as NatWest, have already said they'll consider requests to adjust existing interest cover covenants to give social housing providers additional flexibility as they seek to address the significant retrofit costs coming down the line.

But it's generally accepted that net zero-focused covenants will become increasingly common for all businesses in the near future, and not just from large, traditional lenders. As an example, Scottish Enterprise, the national economic development agency in Scotland has confirmed that it will be seeking net zero plans from proposed investee companies prior to signing off any funding agreements.

So, all businesses should be engaging with incumbent and prospective lenders to understand their (often evolving) net zero-related lending criteria and ensure that they can comply with any additional covenants proposed within the constraints of existing working capital and forecast performance.

Businesses’ level of compliance with their climate-related covenants will also be an area that trustees of defined benefit pension schemes must grasp. This is necessary to ensure that the employer does not unexpectedly have its funding withdrawn, which would have significant consequences for trade and the business's ability to contribute to scheme deficits.

Withdrawal of funding for fossil-fuel producers – where next?

Financial institutions, including private equity, are restricting lending and reducing exposure to fossil fuels to align with the 2015 Paris Agreement’s emissions reduction target. Their intention going forward is to focus on sustainable investments. Coupled with pressures from the Central Bank, regulators and investors, this could lead to significant funding issues for businesses purely involved in fossil fuel production.

Banks around the world – including Australia’s MacQuarrie and China’s ICBC – have made a public commitment to stop financing the coal industry. The industry is currently achieving record-high prices per tonne, up c. four times the commodity value reported last year, so the suggestion from some quarters that banks made these decisions to generate good PR at no loss to themselves is unsubstantiated.

With coal production in the UK now limited – particularly compared to the output of other countries - the announcement by large funders in the domestic market, such as NatWest, that they too would stop funding the industry did not make much noise. But, it does mean that other fossil fuel producers and energy-intensive industries are legitimately asking 'who’s next'?

While over 130 lenders have signed up to a pledge to stop funding coal, there is no such public commitment from lenders on the oil and gas industry. In fact, the Banking on Climate Chaos 2021 report estimates that the world’s 60 largest banks have provided over USD 3.8 trillion to fossil fuel industries since the Paris Agreement was signed at COP21.

Banks with the largest loan exposures to fossil fuel companies

banks-with-the-largest-loan-exposures-to-fossil-fuel-companies.svg

No dramatic changes for oil and gas

So, while COP26 will focus on unlocking finance to support green energy projects in pursuit of net zero, we are not expecting it to generate commitments to legally ban funding of fossil fuel producers. It's also very unlikely that large producers, such as Shell and BP, will cease their oil and gas extraction any time soon. There is a wide understanding of the need to ensure that fossil fuel producers have the funding to continue their supply of secure energy sources. As we transition to Net Zero, these businesses must also have the financial resources to continue exploration with sufficient capex investment in place, avoiding unnecessary environmental harm.

With banking renewals coming up, it will be more important than ever for fossil fuel producers to plan early and approach the widest pool of lending for their refinancing. As lenders continue to sharpen their focus on net zero, it's also vital to avoid any unexpected, or unachievable, asks of your business. This is also true for businesses feeding into the wider supply chain of these operators.

What should you do now?

You need to keep engaging with incumbent and prospective lenders. Stay on top of market developments and have open conversations about which practices you need to change to secure their support.  What’s on their horizon for your net zero covenants, and how can you address these in your business?

Building the cost of covenant compliance into future forecasts, whether it's new equipment that generates less emissions, or the affordability of the interest on any additional debt for financing it, is also important.

It might seem like an additional burden in an already difficult time, but small steps now will be positively received, especially if they're voluntary and not forced on you as compliance requirements. Make sure your proposals are achievable and you provide for unexpected cost changes. 

For more insight and practical guidance on funding your net zero ambitions contact Amy Hamilton or Claire Martin

list item with text on the right

Environmental, social and governance (ESG)

Cultivate purpose-driven growth by meeting your ESG goals

What does ESG mean for your business?