John ConnorThe FCA has published a letter in which it shares insights from its ongoing engagement with banks in the sustainability linked loans market. The FCA comments that SLLs can be a useful transition financing tool for borrowers, but it did have some concerns about the market when it reviewed it in 2023, particularly in respect of conflicts of interest and weak incentives to issue SLLs. Since then, however, it has seen the market mature and, although it still sees concerns around incentives and barriers to scaling that market, it has seen it mature, and notes better practices and more robust product structures.
In particular, the FCA is pleased that KPIs are now generally relevant and aligned to a borrower’s business model, and the market has moved to a few core sustainability performance targets (SPTs) that are material and strategically significant to the borrower business model. It is also pleased that banks have been making efforts to support a borrower in setting stretching targets even where the lender is not the structuring agent. It also notes that banks have been declassifying loans if they fail to meet its SLL criteria, which again shows their willingness to do what they can to ensure high standards.
The banks have welcomed the LMA’s SLL Principles and the FCA has also welcomed the FMSB’s recent guidance.
However, the FCA thinks banks can be exposed to reputational risk because they do not clearly articulate how they account for SLLs in their sustainable financing targets, and this can reduce trust in the SLLs they offer. It is now less concerned about the potential for conflicts, as it has seen practice move towards a more client-focussed approach to banks promoting SLLs, and doing it when the client seems ready .
So on the whole the FCA is pleased with progress, but stresses that it is important for banks to have clear governance and escalation processes in place for sustainability-linked instruments