FCA outlines concerns about sustainability-linked loans market

The Financial Conduct Authority, FCA, has published a press statement and a corresponding open letter addressed at entities providing sustainable loan products to announce the results from a review of the Sustainability-Linked Loans (SLLs) market which is of key significance to enable the transition to zero net carbon emission and thus to achieve the climate goals of the Paris agreement. The key objectives of the review which primarily included interviews with relevant stakeholders was to identify any issues around SSLs (e.g. limited demand or supply of SSLs, greenwashing, etc.) and to explore further opportunities to encourage the use of SSLs by market participants.
#### The key results are as follows:
(1) Not realizing its full potential: Despite the interest from banks in promoting SLLs, the market is not reaching its full potential (yet) due to various reasons (see point (2)). To address this, it may be helpful to increase trust and transparency in the market, e.g. by providing clearer information about the sustainability goals related to SLL products, performance targets, and the impact of achieving those targets.
(2) Borrower concerns: Borrowers may be hesitant to engage in SLLs due to concerns about scrutiny if they fail to meet loan-linked performance targets. Additionally, they may consider the time and costs associated with obtaining an SLL to be too long and too high as compared to a conventional loan. Addressing these concerns would involve providing support and guidance to borrowers, ensuring clear communication about expectations and potential outcomes, and streamlining the SLL process to minimize administrative burdens for firms seeking SSL loans.
(3) Prescriptive framework and science-based targets: Market participants believe that a more prescriptive framework for SLLs would enhance market integrity and reduce the risk of greenwashing. This framework could include more specific and measurable sustainability targets that are based on scientific principles and aligned with international standards. Such an approach would provide greater clarity and credibility to the SLL market.
(4) Conflicts of interest: There is a concern that banks may accept weak targets to fulfill their sustainable finance quotas, leading to conflicts of interest. To mitigate this, it is important to establish robust guidelines and oversight mechanisms to ensure that SLLs genuinely contribute to sustainable development. Independent monitoring and verification of targets as well as transparent disclosure practices can help address these concerns.
(5) Uniform disclosure and independent monitoring: Several banks are calling for uniform disclosure practices and independent monitoring and verification of targets. This would involve borrowers clearly disclosing their transition plans, including their sustainability goals and targets, and having these independently assessed to ensure credibility and accountability.
To conclude, the FCA calls on banks and other lending institutions to consider the observations to inform and guide their ongoing transition finance strategy. They are also urged to consult the Climate Transition Finance Handbook of the International Capital Market Association and the Sustainability-Linked Loan Principles issued by the Loan Syndications and Trading Association (LSTA) in both their dealing with corporate clients and setting sustainability targets and product designs of sustainability-linked loans.
By addressing the concerns raised by stakeholders and implementing measures such as increased transparency, clearer guidelines, science-based targets, and independent monitoring, the SLL market can evolve into an effective tool for financing sustainable economic activity and supporting the UK’s transition to a net-zero economy by 2050. The FCA will continue to closely monitor the market.