Sustainable finance is not currently the hot topic that it was a couple of years ago. Challenging economic conditions have led firms to prioritise other issues, and there have been concerns around greenwashing.

But mid-market firms should not be lulled into a false sense of security. The forces driven by ESG that influence lenders to become increasingly selective over which borrowers they support, and at what price, are not going away and will only ramp up over time. Jon Bramwell shares results from our survey of mid-market lenders to understand the direction of travel.   

We surveyed nearly 50 UK-based lenders to understand their attitude and strategy towards ESG and sustainable finance for the mid-market, and what this means for borrowers. This follows a similar survey undertaken in 2022. 

The sustainability footprint and emissions profile of a borrower directly impacts on a lender's own sustainability credentials. Mid-market firms need to ensure they develop a sustainability strategy backed by good quality data and clearly communicate it to their lenders – or over time risk a lender withdrawing their support.    

Christopher McLean, Partner

  • Christopher McLean, Partner

    "Mid-market firms need to stay ahead of their sustainability story to maintain access to capital. We help firms of all sizes with their sustainability strategy, as well as provide ESG assurance for sustainability linked loans."

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More friction in the market, but direction of travel remains the same  

In 2022, we conducted a similar survey of mid-market lenders. At that time, while mid-market issuance of green loans and sustainability linked loans (SLLs) lagged behind that of large, listed corporates – momentum around the ESG agenda was building for the mid-market. This was driven by lenders’ own sustainability targets and disclosures, and their desire to reduce the emissions produced by their mid-market borrowers.  

Since then, against a backdrop of inflation, rising interest rates and geopolitical instability there's been a hiatus in this momentum across the board. Global sustainability linked loan issuance fell 55% in 2023 amid concerns around greenwashing and regulatory uncertainty. In the mid-market, we've seen a reticence to take on more borrowing, regardless of whether it's sustainability-linked or not. Many mid-market firms also have concerns around the availability of reliable data and the cost of setting up sustainability linked loans.  
This is coupled with more scrutiny from lenders – both around the ESG credentials of the borrower as well as the parameters of any ESG based loan – as they seek to demonstrate the sustainable finance they issue is robust and credible.

Sustainable finance products act as facilitators to change the behaviour and sustainability credentials of borrowers. They're also inextricably linked with a lender’s own sustainability ambitions. Mid-market firms need to be cognisant of this. Those that don't have a roadmap in place to improve their ESG credentials may find it negatively impacts their options as soon as their next financing round. 

That 41% of lenders said that they could anticipate a time when sustainability-linked key performance indicators (KPIs) and sustainability performance targets (SPTs) could become a compulsory part of any loan document illustrates this.

ESG continues to factor into a lender’s credit decisioning

Virtually every large bank has made a commitment for their balance sheet to be net zero by 2050. Some have gone further. For example, Lloyds Banking Group has the target of reducing the carbon emissions they finance (scope 3 emissions) by more than 50% by 2030 and Barclays has set reduction targets for financed emissions across eight key sectors. NatWest has outlined steps to at least halve the impact of their financing activity by 2030, and HSBC has set financed emission targets for 2030 on a sector-by-sector basis. The pressure on lenders globally to publish their transition plans and greenhouse gas (GHG) emissions steadily increases. Many lenders in the UK already voluntarily published this information, but this may soon become mandatory. The FCA is expected to consult in 2025 on proposals for listed companies in the UK to report in line with the International Sustainability Standards Board’s global sustainability disclosure standards published in June 2023. Final rules on mandatory disclosures for listed issuers may be in place by the end of 2025, potentially taking effect as early as 1 January 2026. 

Given that a high emitting borrower directly impacts the emissions disclosure and net zero transition of their lender, mid-market firms should be aware that some lenders may choose to avoid high emitting firms altogether.  

It's vital that mid-market borrowers understand that their ESG credentials feed into a lender’s credit decisioning. This inevitably translates to both the price and availability of capital. While no-one is expecting overnight change, firms need to develop their sustainability journey, and be able to effectively communicate that with stakeholders.

Mid-market lenders believe a borrower’s ESG status may impact the cost and availability of credit

This is a crucial point for borrowers to understand. As soon as lenders are required to allocate a greater amount of capital for a loan to a mid-market firm with poor ESG credentials, lenders are likely to have to charge more for such loans or may choose not to make the loan at all.

Mid-market borrowers need to be aware that if they don't have a credible transition plan, or a plan that conflicts with a lender’s own sector ambitions, it's easy to foresee that lenders may look to reduce their exposure.  

Increased scrutiny has led to greater transparency and rigour in the market

In June 2023, the FCA conducted a review of the SLL market amid concerns that it isn't working as intended. It found issues of credibility, where SPTs aren't robust enough and don’t stretch the borrower to enact meaningful changes in behaviour. Secondly, KPIs, which track performance against the targets, can be too weak. The FCA has stated it's “keen to ensure that the sustainable finance market works well, and that market integrity is maintained".

Our survey responses illustrate how the market is responding to these concerns.

While it's in everyone’s interest that SPTs and KPIs are credible, there's an equilibrium to be struck, where the SLL market is robust and commercial and both borrowers and lenders are incentivised to partake.

This would go some way to address the regulatory concerns around weak incentives for borrowers to issue SLLs.  

For many mid-market firms, the cost of setting up an SLL can be a disincentive. The model provisions are intended to provide consistency of drafting and contribute to lower transaction costs. But for many corporates, it's the cost of embedding ESG throughout the organisation and collection and reporting of data, versus the margin savings, that can appear less attractive in the face of competing demands on resources.

Interestingly, while a breach of a sustainability provision is rarely, if ever, an event of default, 29% of lenders said that they may consider a beach of sustainability provision to trigger an event of default in the future. This only illustrates how integral a borrower’s sustainability journey is to some lenders.

While recognising that the market for third-party opinions is relatively underdeveloped, advisers can still bring a level of comfort for lenders. They can also act to homogenise the market where there may be regional or sector differences.

Questions around the quality and availability of data have been a hurdle for many market participants – it was considered the most significant obstacle to the integration of ESG issues in the syndicated loan market in the LMA’s end of year survey.  

While the market still has some way to go in terms of data collection and verification, it's common for larger corporates to have external consultants providing ESG assurance. For the mid-market, there will always be the challenge around the cost of assurance versus the size of the transaction.  

Supply chain pressure also impacts mid-market firms  

Mid-market suppliers form part of the scope 3 emissions disclosures of larger, listed corporates who, in turn, are increasingly required to disclose their own emissions. According to the Carbon Trust, scope 3 emissions created by a company’s supply chain represent 65-90% of total emissions at many firms.  

Mid-market firms therefore need to meet the expectations of their large clients in order to win and maintain contracts.

As such, sustainability-linked supply chain finance is offered by an increasing number of large businesses (for example, Tesco), enabling their suppliers to achieve preferential financing rates based on their ESG credentials.    

Mid-market firms are already at risk of losing business if they aren't able to prove they're taking active steps to reduce their emissions, and this will only continue.  

Wide variety of lenders at different stages of sustainability journey  

There are a wide variety of lenders who serve the mid-market, from the big retail banks and challenger banks to debt funds and ABLs. Each lender will be at a different stage of their own sustainability journey, with the large retail banks leading the way in terms of transition planning and emissions disclosures. Many non-bank lenders currently place less emphasis on sustainability, although some limited partners (LPs) will be driving change in the private credit market, particularly as many of these LPs are also shareholders in major banks across the world.

However, the large retail banks still play a major part in the mid-market lending landscape. The Business Finance Survey from the British Business bank shows that 51% of smaller businesses only approach their main bank when seeking finance. With more focus on emissions reporting through regulation and stakeholder interest, we expect more and more lenders will necessarily focus on the ESG status of their borrowers.

Despite the headwinds around ESG over the past couple of years, the direction of travel remains the same. Lenders will increasingly be looking for mid-market firms to commit to ESG targets, and a key part of this will come via sustainable finance incentivising a positive ESG impact. Access to capital and the cost of that capital is likely to become increasingly dependent on this.

Our debt advisory and ESG advisory teams work with mid-market firms to help develop and communicate their bespoke strategy to lenders. We provide ESG assurance services and help mid-market firms access liquidity via sustainability linked loans, bringing potential margin discounts and allowing firms to demonstrate their commitment to sustainability to stakeholders.

For more insight and guidance, get in touch with Jon Bramwell or Christopher McLean

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News release

Study shows lenders anticipate growing influence of ESG credentials on mid-market borrowing

New research from leading business and financial adviser Grant Thornton UK LLP has found that ESG credentials are an increasingly important factor for mid-market businesses seeking to access capital.