The market for sustainability-linked loans (SLLs) has matured over the past couple of years, with better practice and more robust product structures, the Financial Conduct Authority (FCA) has said.
It made the remarks in a letter following up on comments it made in 2023 in response to concerns about the integrity of the SLL market.
In its new letter, the regulator said there were still barriers to scaling the market and there were “some concerns around incentives”, but that the improvements it had observed “are important steps in the development of a credible transition finance ecosystem”.
Improvements cited by the FCA include more meaningful key performance indicators and sustainability performance targets, with banks working to support borrowers in setting more stretching and relevant targets.
“Banks appear to value the role SLLs can play as an important strategic tool, facilitating deeper engagement between borrower and lender on long-term investment plans,” the FCA said.
It also said that some banks have used declassification as a sanction against borrowers, saying this showed that standards have been raised “and banks are willing to exert the full range of measures to maintain higher standards”.
The regulator also addressed banks’ own sustainable financing targets and how SLLs relate to these.
It said it was encouraged by the positive action to raise standards within the SLL market, but cautioned that “a lack of clarity in banks’ articulation of how they account for SLLs in their sustainable financing targets can leave them exposed to reputational risks and reduce trust in the SLLs they offer”.
Conflicts of interest, incentives
Reflecting on developments surrounding incentives and conflicts of interest, FCA said it had seen signs of a shift towards a more client-focused approach, promoting SLLs only when a client was deemed ready.
“We had previously noted that banks seemed keen to promote SLLs, incentivised by achieving sustainable financing targets,” it explained.
“This approach of prioritising the product over client readiness had appeared to threaten the integrity of the market.”
Regarding conflicts of interest, the regulator noted efforts by some banks to mitigate this if they worked with borrowers to ensure future financing could involve an SLL.
“Nevertheless,” it added, “given the significance of syndicated credit facilities in relationship lending, and the potential for client relationships to disproportionately drive a bank’s decision to provide an SLL to a client, we would encourage banks to remain alert to potential conflicts of interest.”
The regulator said it would continue to monitor the SLL market as part of its wider work on transition finance, and encouraged engagement collaboratively with the work of the Transition Finance Council, “to build alignment in approaches to transition finance”.
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