The Financial Conduct Authority (FCA), the UK conduct regulator for financial services firms and financial markets, announced today the publication of a letter to banks and companies, outlining a series of market integrity concerns related to the sustainability-linked loan (SLL) market that it said could hold back the development of a useful net zero transition financing tool and raise the risk of greenwashing.

Sustainability-linked debt is one of the fastest growing areas of sustainable finance, with attributes including interest payments tied to an issuer’s achievement of specific sustainability targets. Corporate interest in sustainability-linked loans has grown rapidly over the past several years, as the financing provides flexibility to use proceeds for general corporate purposes, while with instruments such as green bonds, raised funds can only be allocated to specific categories of green projects.

After an extended period of growth, the FCA noted the emergence of negative media coverage of the SLL market, with concerns about the robustness of market integrity, which the regulator added were corroborated with market intelligence gathered earlier this year.

In the letter, signed by FCA Director of ESG Sacha Sadan, the FCA wrote:

“A number of the issues identified have informed our observations about the possibility of potential risks to market integrity and suspicion of greenwashing in the context of SLLs.”

Integrity-related concerns included weak incentives in the sustainability-related terms of the loans, and low-ambition sustainability targets and indicators chosen for the loans.

In subsequent engagements with market stakeholders, the FCA also said that it also noted potential conflicts of interest, with banks in some cases providing remuneration incentives to promote SLLs in order to help achieve their sustainable finance targets, potentially leading them to accept weak Sustainable Performance Targets (SPTs) and Key Performance Indicators (KPIs) in the loan agreements.

Observations from the engagements included very small step-ups in interest costs for investment grade SLLs in which the issuer missed a performance target, “at around 2.5bps and capped at circa 5bps.” Additionally, the FCA pointed out a sentiment among banks that relationships, rather than a borrower’s sustainability credentials disproportionately drove banks’ decisions to participate in SLLs.

While the FCA noted that it does not directly regulate the SLL market, the regulator said that it will continue to monitor the market “with a view to considering the need for further measures to support the development of a robust transition finance ecosystem.”

The letter also highlighted the recently revised Loan Market Association’s Sustainability-Linked Loan Principles (SLLP) as a source to help address the concerns raised.

Sadan said:

“Sustainability-linked loans are important financing tools for the transition to a low carbon economy. However, there are some issues holding back more widespread adoption and market growth.  

“We want to build trust and integrity in these products. We hope all market participants will consider carefully today’s findings as well as the existing principles published by the Loan Market Association.”