By Paul Davies and Aaron Franklin
Royal Philips, a health technology company, has recently agreed to an innovative revolving credit facility agreement with a margin linked to the company’s year-on-year sustainability performance improvement. The agreement was entered into by a consortium of 16 international banks (led by ING, as Sustainability Coordinator) and provides for a commitment of €1 billion. Royal Philips’ current sustainability performance was benchmarked by the environmental, social and governance rating agency Sustainalytics: if the sustainability rating increases, the interest rate decreases and vice versa.
ING has monitored the sustainability performance of the companies it lends to since 2015. However, this is, to our knowledge, the first example of a credit facility structured so that sustainability performance is rewarded automatically. ING has flagged that this is a way to “support, motivate and reward” their clients “in their aim to become even more sustainable” and that it represents a “mind shift in corporate financing”.
The Royal Philips facility is different from typical green finance in three ways. First, it is extremely rare for any financial instrument linked to green investment criteria to provide a concrete cash benefit to the issuer. Most investors in green bonds, for example, are constrained by their fiduciary obligations to not pay more for bonds with non-financial attributes like green uses of proceeds. Second, most financial instruments linked to green investment criteria focus on how the funds will be used, requiring the issuer to declare its intention to use the borrowed funds only to finance “eligible green projects”. The Royal Philips facility, in contrast, is agnostic on how funds are used. The only feature related to green or sustainable investment, is the adjustment of the margin based on changes in the borrower’s sustainability rating. Third, the trigger for margin adjustments, the sustainability rating, is more expansive than the concerns of a typical green financial instrument in that it encompasses social and governance concerns, as well as environmental concerns.
This landmark deal highlights an important evolution in the world of investments linked to sustainability criteria. While the green bond market has rapidly expanded, the widespread view of the market has remained that investors do not pay more for green features. Other examples preceding Royal Philips’ departure from the norm include the World Bank’s March 2017 bond that linked interest payments to the performance of an index including only the equity of companies found in the Solactive Sustainable Development Goals World Index and Unibail-Rodamco’s April 2017 revolving credit facility arranged by Lloyd’s Commercial Banking with a margin tied to the Paris-based property firm’s performance under three “Green KPIs”.
Significant numbers of borrowers have been turning to sustainable investment over the past four years based on benefits that are largely perceived as less tangible, such as furthering the corporate sustainability strategy, diversifying the investor base and attracting new investors. Any move towards conferring an economic benefit in exchange for sustainability performance is sure to make a material impact on the market. Royal Philips’ facility may be one step closer to a tipping point.
