Lenders' commitment to Net Zero transition is driving increased focus on the ESG status of their mid-market and large cap borrowers. Christopher McLean and Jon Bramwell explain why firms in the food and beverage sector should consider sustainable finance as part of their ESG strategy, and how it can align the interests of both borrowers and lenders.

Food and beverage (F&B) is the UK’s largest manufacturing sector, characterised by high-energy consumption and accounting for a third of all global greenhouse gas emissions. As such, the industry faces scrutiny from consumers, lenders and investors on their sustainability credentials.

Large, international F&B companies are raising sustainable finance to indicate to the market and their stakeholders that they're embedding ESG at the heart of the business. Recent sector activity includes issuance from Mars, Bacardi and Compass Group. There's been less take up by mid-market F&B firms to date.

However, lenders – from high street banks to debt funds - are increasingly focusing on the ESG credentials of all their borrowers, including the mid-market. Our survey of lenders showed that 93% expect sustainable finance in the mid-market to increase in the next few years. It also showed that half of these lenders believe it will increase significantly.

Businesses in the F&B sector need to know that a firm’s ESG credentials could start impacting their ability to access finance.

A borrower’s ESG status directly impacts the ESG credentials of a lender

Lenders are under pressure from regulators, investors, and limited partners (LPs) to improve their own ESG credentials. For example, for many, mandatory transition plans showing how a firm will achieve net-zero are on the horizon. Every large bank has made a commitment for their balance sheet to be Net Zero by 2050. Others, such as Lloyds have gone further and pledged to achieve net zero-carbon operations by 2030.

There's also increasing pressure for lenders to disclose their scope 3 emissions – those emissions produced by their borrowers. These are, on average, over 700 times higher than a lender's own operational emissions (scopes 1 and 2). Many larger lenders already disclose this information. For example, Natwest has published its target of reducing the emissions of their financing activity (scope 3) by 50% by 2030.

In October 2023, the Department for Energy Security & Net Zero launched a Call for Evidence as to whether the Government should adopt scope 3 emissions reporting in the UK. This followed the publication of IFRS S2 in June 2023 by the International Sustainability Standards Board (ISSB) which requires entities to report their emissions, including scope 3. There's widespread support for this among UK lenders as evidenced by UK Finance’s response.

This is significant. The ESG status of borrowers in the F&B sector directly impacts the ability of lenders to meet their own ESG targets. For example, agriculture represents 1.2% of NatWest's gross lending, but is the largest sectoral contributor to the bank's total financed ambitions. This has led the bank to state that "our ambition to help our farming customers reduce their collective carbon footprint is also a vital part of our own ambition to at least halve our financed emissions by 2030".

The natural extension of this is that lenders may favour borrowers with better ESG credentials, and those without developed ESG credentials may find it increasingly difficult to access capital on their usual terms.

A borrower’s ESG status is becoming as relevant to a lender as credit risk.

F&B firms, whether mid-market or large cap, need to be aware that each time they come to refinance with their lender, the pressure to demonstrate their ESG credentials will increase.

What is sustainable finance?

There are typically two types of sustainable finance available to borrowers. 'Green' or 'social' loans, where the proceeds of the loan need to be used for a green or social project, and sustainability-linked loans.

A sustainability linked loan (SLL) is for general corporate purposes, but includes targets (sustainability performance targets, SPTs) linked to performance in either environmental, social, or governance aspects of the business. These SPTs are measured periodically by key performance indicators (KPIs). If the SPTs are met, then the borrower typically benefits from a reduction in the margin payable on the loan. SLLs are all offered by bank lenders, asset-backed lenders (ABL) and non-bank lenders.

In the F&B sector, examples of SPTs might include environmental targets, such as reducing GHG emissions or water consumption. Examples of social targets might include improving the health and welfare of growers or aspects of community development.

While there's been some uncertainty around the appropriate setting of SPTs and KPIs in recent months, it doesn't change the value that lenders attribute to sustainable finance, or the momentum we see in the mid-market. Committing to track, monitor, and improve ESG credentials via loan documentation lines up the interests of both lender and borrower, and sends a powerful signal to other stakeholders about a firm’s intentions.

ESG is important throughout the supply chain

ESG credentials are becoming more important than ever for winning contracts in the F&B sector. A 2022 survey has shown that within a 12-month period, 21% of retailers in the UK cancelled contracts with their suppliers worth £7.1 billion for failing to meet sustainability criteria.

73% of the world’s largest companies in the F&B sector have a sustainable development target, according to the World Benchmarking Alliance. These targets include a company’s entire supply chain, meaning the mid-market F&B firms that form part of the supply chain will increasingly need to prove their sustainability credentials to win contracts.

There's also growing focus on large corporates publicising their own scope 3 emissions - emissions that are indirectly created by a company's supply chain and represent 65-90% of all emissions at many companies according to Carbon Trust. Mid-market firms - regardless of size - who feed into these supply chains may find themselves losing key customers or penalised if they're unable to meet ESG expectations.

Sustainable finance is an effective way of proving to key customers that a firm can commit to their sustainability credentials. That Tesco offers its supply base sustainability-linked supply chain finance, enabling its suppliers to achieve preferential financing rates based on their ESG credentials is illustrative of this.

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How can food and beverage firms respond?

Not paying attention to your ESG credentials could start to impact an F&B firm’s ability to access finance. While issuing sustainable finance isn't compulsory, we expect that it will become increasingly widespread across borrowers of all sizes given the pressures on banks and debt funds to demonstrate they're lending to firms which are able to monitor, track, and enhance their ESG credentials.

It's something all F&B firms need to consider in their next financing round. Even if that next financing round is several years away, lenders need to see that a firm’s ESG strategy has been embedded in its daily business activities and – crucially - it has quality data, collated over a period of time, to support and measure its progress.

For more information and advice, contact Christopher McLean or Jon Bramwell.

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