Sustainability Linked Loans

Abstract

This study examines a novel form of debt financing – sustainability linked loans (SLL). SLLs are obtained by companies committed to sustainable growth in line with climate change goals. Compared to funding from most traditional green instruments, which is restricted to specific projects, SLL funds can be used for general corporate purposes, but the interest rate on the loan is linked to certain Environmental, Social, or Governance (ESG) metrics. The typical SLL credit spread is reduced by 2 to 25 basis points if custom ESG targets are met. We show that despite a negative market reaction to the announcement and activation of SSLs, SLL funding helped issuing companies better withstand the liquidity shock caused by the COVID-19 pandemic. SLL issuers outperformed their peers around a series of pandemic-related events. Our study also provides causal evidence that meeting non-financial performance targets can directly affect market valuation, beyond securing access to liquidity on the credit market.

Keywords: Sustainability linked loans, Sustainable finance, ESG benchmark, COVID-19, Resilience

JEL Classification: G32, G34, G38