The UK results of Grant Thornton’s H2 2022 International Business Report*, a survey of around 10,000 mid-market businesses globally, shows that mid-market firms are increasingly aware of the benefits of embedding sustainable finance into their corporate ESG strategies.
Key findings include:
- 1 in 4 (25%) mid-market firms currently have a sustainability linked loan (SLL) in place or are in discussions with lenders regarding a SLL
- Nearly 1 in 3 (31%) mid-market firms will consider a sustainability linked loan (SLL) when they consider their next debt raise/re-finance
- Nearly 2 in 3 (65%) understand how their ESG position influences the lenders’ risk appetite and the price they pay for borrowing
This is promising and illustrates how momentum is building in the mid-market around ESG – just a short time ago, sustainable financing was dominated by large, listed corporates.
However, these figures show there is still some way to go in the mid-market before sustainable financing is fully embedded as part of a firm’s ESG strategy.
Our survey of over 40 mid-market lenders in 2022 found that 93% of those surveyed expect ESG related lending in the mid-market to increase over the next few years – so while management faces many competing priorities brought about by the economic downturn, it is important for mid-market leaders to continue to focus on this area.
The majority of lenders have an ESG strategy to extend sustainable finance to the mid-market
According to our survey of over 40 mid-market lenders in 2022:
- most lenders (57%) have an ESG lending strategy for mid-market companies
- this figure is increasing all the time, and we are actively helping lenders set up new ESG loan governance frameworks to help embed their ESG strategy in their operations
- 93% of lenders surveyed expect ESG related lending in the mid-market to increase
- this is compared to a back book of existing ESG-linked lending of less than 10%, showing a change in the direction of travel.
So, it is clear that sustainable finance for the mid-market is becoming increasingly important for lenders. This is motivated by pressure from regulators, investors and limited partners (LPs) as scrutiny on a lenders’ own ESG credentials continues. For example, virtually every large bank has made a commitment for their balance sheet to be net-zero by 2050.
Some have ambitious plans to reduce the amount of carbon they fund by as soon as 2030 – Lloyds and NatWest plan to reduce carbon they fund by 50% by 2030 whilst HSBC, Santander and Barclays have made various pledges to reduce funding for certain high carbon sectors by 2030. The ESG status of their borrowers is a major factor in them being able to achieve this.
ESG plays a key role in lenders’ credit processes
ESG considerations are becoming hardwired into lenders’ credit risk assessments, with 85% of mid-market lenders saying that a firm’s ESG status or its ability to transition to net-zero influenced their credit risk assessment.
This is crucial – a borrower’s carbon emissions profile is becoming as relevant to a lender as credit risk in determining who to lend to and on what terms. For example, a carbon transition risk assessment is now a compulsory part of the annual credit review for all major banks – a process that did not exist just a few years ago. Mid-market firms therefore need to prioritise their ESG agenda to maintain competitive advantage and preserve access to capital.
As we look to the future, it is possible that lenders will require mid-market firms to take up sustainable finance in order to ‘join the dots’ on their own carbon reduction strategies.
Sustainable financing is part of a firm’s ESG strategy
A sustainability-linked loan demonstrates a firm’s commitment to ESG to its lenders, investors and other stakeholders, including employees and customers. Tying sustainability goals to their funding is a powerful way to demonstrate to the market how seriously the business takes ESG.
Lenders’ ESG strategies typically relate to two main types of sustainable lending:
- Green loans where the proceeds of the loan need to be used for a ‘green’ project
- Sustainability-linked loans where the loan is for general corporate purposes, but includes targets, or key performance indicators (KPIs), linked to the business’ performance, in either environmental, social, or governance aspects
Despite a slow-down in issuance of SLLs in the primary market in 2022 (due to the Russian invasion of Ukraine and rising interest rates), SLLs remain an integral part of both bank and non-bank lenders ESG strategies. Sustainable finance is no longer the preserve of large, listed corporates, but the mid-market too.
Sustainable financing provides proof of a firm’s ESG strategy and includes inbuilt metrics and KPIs to demonstrate it is hard-wired into a firm’ business model. This can be powerful evidence of a business’s commitment to its sustainability goals and can prove helpful in the support of tenders for business with their customers.
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Lenders will be required to report on scope 3 emissions
Lenders are already required to publish their transition plans for achieving net-zero. Once proposals from the ISSB come into effect, they will also be required to disclose their scope 3 emissions.
For a lender, scope 3 emissions are those emissions produced by their borrowers (eg their ‘financed’ emissions) and are, on average, over 700 times higher than a lenders’ own operational emissions. This is significant. How long will a lender continue to finance high emitting borrowers, or borrowers without a credible ESG strategy when it reflects poorly on their own targets?
The emphasis on reporting a lenders’ scope 3 emissions only increases the pressure on lenders to ensure their borrowers have effective ESG strategies in place. Over time, the natural extension of this is for lenders to restrict access to cost effective capital for borrowers who do not match up to their own sustainability objectives.
ESG increasingly a factor in winning contracts
Larger, listed corporates are under pressure from both stakeholders and regulators to show they are focussed on ESG throughout their supply chain. 75% of global annual revenues are now generated by listed firms with net-zero targets and therefore the mid-market companies that feed these supply chains are being asked to demonstrate they can meet these ESG expectations.
The same is true for public sector contracts – any firm bidding for a contract worth £5 million or more for the UK Government, including the NHS, must show they have a credible plan for reaching net-zero by 2050. Contracts can be won if a firm is able to demonstrate a clear sustainability story. Equally, we have seen clients who have lost business due to not meeting ESG requirements.
As lenders prioritise ESG in their investment decisions for the mid-market, borrowers are increasingly motivated to embed their ESG strategies, with sustainable finance being integral to this process. Despite competing priorities in 2023 and beyond, sustainable financing should remain important to mid-market borrowers because it is important to their lenders.