Sustainability-linked finance refers to loans at a reduced interest rate provided that meaningful targets are set on a range of environmental, social and governance criteria. If the targets are not met, the borrower incurs an interest rate penalty. By integrating social and governance indicators, it has a broader scope than green finance, which tends to focus on climate action and environmental indicators.
Launched in 2017, the market has grown rapidly, with companies across all industry sectors under pressure from external and internal stakeholders to improve their green credentials.
Last year alone, more than $700 billion in sustainability-related loans and bonds were issued, according to figures from Bloomberg.
From a sustainability perspective, the global food system faces a contradiction. On the one hand, the industry provides jobs (especially jobs for young people) around the world, and with it the possibility of sustainable economic growth for emerging and developed economies. On the other hand, however, food production comes with an unavoidable contribution to global greenhouse gas emissions and environmental degradation.
With this in mind, the food production industry is increasingly turning to sustainability-related financing to lessen its impact on the planet. Last year, 12% of loans to the agribusiness sector were linked in some way to sustainability.
The long supply chain associated with food production offers a number of indicators that can be measured when setting up sustainability-related finance. A company’s carbon footprint can be reduced by switching to more efficient heating and cooling systems, as well as switching to a more fuel-efficient transportation fleet. Businesses can look to the three Rs – reduce, reuse, recycle – to reduce the amount of waste they send to landfill, and water use is another area that can be measured and targets set. .
The ease of tracking different indicators can vary between different sub-sectors of the food production industry, with some parts of the supply chain being more opaque than others. This has increased the importance of leveraging the right technology, in order to receive the right data. Usually, no more than a handful of indicators will be used when setting up a sustainability-linked loan. Sucafina, an international coffee producer, for example, tied the interest rate it paid on a sustainable loan only to reducing food waste, and only to reducing carbon in the second.
Carbon reduction targets have also featured in HSBC’s sustainable funding to fresh fruit and vegetable growers in Singapore (Sustenir) and the UK (DPS) to help both companies integrate vertical farming techniques in their production, resulting in a 90% reduction in CO2 emissions compared to traditional farming methods.
As inflation has risen around the world in recent months, interest rates have risen in many developed and emerging markets as governments seek to use monetary policy to combat rising prices. Food producers considering conventional borrowing will end up passing on higher borrowing costs to consumers, which is detrimental at a time when global food prices are already rising due to the situation in Ukraine, rising energy prices and continued supply chain constraints due to the Covid-19 pandemic.
By using sustainability-linked financing, food producers can secure lower borrowing rates while simultaneously reducing their impact on the environment and contributing to the communities in which they operate – a win-win situation. Increased use of sustainability-based finance is also a win-win situation for banks and other sustainable lenders, helping to make their loan portfolios more sustainable as they strive to achieve their own internal ESG goals. It’s no surprise, then, that HSBC has set aside $1 billion globally to fund sustainable businesses and develop climate solutions.
Between early February and early March of this year, oil and gas prices rose by around a third globally and have been on a steady swing ever since thanks to the situation in Ukraine and other underlying geopolitical factors. underlyings. The cost of energy produced from clean sources is less impacted by such shocks, which makes it more stable. A greater reliance on energy from clean sources will make the food production industry less susceptible to external factors – another benefit of sustainability-related financing.
The risk for sustainability finance is that the word “meaningful” is subjective; the mix of ESG indicators does not allow for an accurate comparison and may confuse lenders, and the magnitude of the penalty if targets are not met is inconsistent and may not sufficiently motivate borrowers to achieve their targets. If these challenges are not addressed, markets linked to sustainable development risk becoming a means of laundering finance, which will lead to a loss of confidence in this potentially important financial instrument.
Jeffrey Beyer, who is the managing director of UAE-based sustainability consultancy Zest Associates and one of the experts speaking at Gulfood Manufacturing – which will be held November 8-12 – shared his recommendations on how to make finance related to sustainable development more robust in the face of the above challenges.
Beyer recommends three improvements:
- ESG criteria must be disaggregated. It is illogical to compare, for example, an occupational health and safety objective with a greenhouse gas reduction objective. Disaggregation would create bonds and loans related to climate, environment, governance and social. This way, lenders know exactly what types of goals they support, and goals can be more easily compared between borrowers.
- The word “significant” should be better defined. In the case of greenhouse gas emissions, meaningful targets are helpfully set by the Science-Based Targets Initiative, which offers industry guidance and advice on the size and speed of targets that will prevent the worst effects of climate change. climate change. Similar approaches could be taken for other measures, for example, aligning with the UN Sustainable Development Goals for social targets or the OECD for best practices in governance.
- Sanctions for failure to meet targets should be strict and consistent. Tiny penalties are unmotivating, and some durability penalties have been as low as 1 basis point (0.01%). This risks allowing borrowers to obtain cheaper financing, then fail to achieve their goals and get away with a financial ‘slap on the wrist’. Stronger and more motivating penalties should be introduced to incentivize companies to achieve their clearly defined goals.
In conclusion, sustainability-related instruments have the potential to unlock hundreds of billions, if not trillions, of much-needed investment. They open up sustainability to all businesses, including those in the food and beverage sector, and can help finance businesses to transform into greener, fairer and better-run businesses. It is essential to ensure that this new, fast-growing financial instrument is robust and lives up to its enormous potential to bring real improvements to communities, investors and the environment.
Mark Napier is the Vice President – Exhibitions at Dubai World Trade Center