Banks have a key role on the journey to net carbon zero. But that doesn’t mean they have an easy job | Content partnership
When retirement village operator Metlifecare took out a $1.25 billion loan and a $75 million hedge contract, not only did it have to ensure it could pay the money back to its bank lenders. It also had to meet a bunch of externally-audited sustainability-related targets.
They included building six new aged care facilities which meet the highest level of Green Star environmental building rating standards, and implementing annual all-company targets in line with the Science Based Targets Initiative goal of limiting global warming to 1.5C.
If Metlifecare doesn’t meet its targets, it will end up paying significantly more to its bank.
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If it does meet them, as well as paying a lower interest rate, it helps Swedish owner EQT meet its ambitious 2030 emissions reduction targets.
There's also a benefit to Metlifecare’s bankers which, like most in the finance sector, are under increasing pressure to use their financial clout to help achieve global climate change emissions targets.
BNZ is the sole participating bank in the $75 million Metlifecare interest rate hedging deal and the first New Zealand bank to sign up to the Net Zero Banking Alliance, a UN-convened group of 116 banks from 41 countries.
Adam Coxhead, head of BNZ’s sustainable finance team, says there are two main types of sustainable finance products being used by banks. The first is lending money to ‘green’ projects - a company wanting to build a wind farm or get rid of fossil fuel vehicles, for example.
Last year, KiwiRail announced it had secured a $350 million loan to buy two new Interislander ferries. The ferries will use battery and onshore power as well as diesel, cutting the Interislander’s emissions by 40 percent in the first phase, and potentially in the future allowing the company to go to zero emissions ferry sailings.
This loan was the first in the shipping sector to be certified by the Climate Bond Initiative, meaning KiwiRail had to demonstrate a “clear path for fuel and propulsion systems achieving zero carbon emissions by 2050”.
The second type of sustainable finance product being used by banks is when they provide a normal loan, bond or derivative for general corporate purposes, but as part of the deal include environmental or social KPIs (key performance indicators) which the borrowers are measured against.
That’s the category the Metlifecare deal comes under. While the bank isn’t prescriptive about what the funds are used for, there are embedded sustainability targets the borrower must track and report against.
Depending on whether they meet them, the cost of the financing could go up or down.
Coxhead says emissions reduction is the most common KPI in these finance deals, although there are often social, and sometimes governance-related targets too.
“Environmental KPIs make up probably 70-80 percent and of those probably two-thirds are emissions-related.”
A four-step process
He says setting up one of these sustainability-linked loans requires more preparation - sometimes considerably more - from the company wanting to borrow money than a so-called ‘normal’ loan.
In particular, the borrower needs to identify its most important sustainability issues in discussion with stakeholders, including staff, shareholders, customers and potentially suppliers and regulators.
“If a customer wants to use sustainable finance, it helps if they have done some deep thinking around their business’ sustainability goals. It might be around emissions reduction, waste management, or diversity and inclusion.”
Once a company has understood what its material issues are and established a baseline, it then needs to set performance indicators that relate to those issues, so it can track and improve performance over time, Coxhead says.
The final stage is to set ambitious and measurable targets around those indicators.
“The bank is wanting to know the KPIs are covering the same material issues the company has identified; issues which are most relevant for the sector. We also need to be confident the targets represent an ambitious level of change beyond business as usual.
“To calibrate those targets BNZ would be looking at the baseline, which is ideally three years’ data or more, plus any other external reference sources which might be relevant, whether that’s peers or some sort of industry benchmark.
“Performance against the KPIs needs to be audited on an ongoing basis, typically by the company’s own auditors.”
The final piece of the puzzle is to get an independent party to review the deal and confirm it meets international standards, for example those set by the Asia Pacific Loan Market Association.
Intermediate steps
It's also necessary to get the pathway right.
“Often emissions targets are very long-dated - net zero by 2050. So how do you address these considerations through a financing instrument which is typically three to five years?”
Under the Net Zero Banking Alliance, BNZ has to set 2030 targets for its own financed emissions; in a similar way, nearer-term targets are negotiated with clients too, Coxhead says.
“If you are putting in place a five-year loan today, out to 2027, what you would need to do is calibrate a trajectory throughout the life of the loan that gets the borrower on the right path to achieving their 2030 targets - or beyond. You set an annual trajectory that shows a reduction in emissions in line with that pathway.
“Another example might be where a material part of a company’s emissions comes from a fleet of vehicles, so there might be an ambitious target to convert a certain percentage of their fleet to EVs each year.”
The first time a customer uses sustainable finance it takes a bit more time and effort, Coxhead says. But as banks and customers get used to the new sustainability focus, the process will become easier.
Sustainable finance for farmers and SMEs
The other challenge for banks and customers is that the sort of high engagement needed for this sort of sustainability loan is harder for small and medium-sized enterprises (SMEs) looking for a smallish sum of money.
“It’s resulting in banks thinking ‘How can we provide these sorts of products but in a lower cost, standardised sort of way, like we do for loans normally'.”
In May, BNZ launched New Zealand’s first sustainability-linked loan for farmers, offering pricing benefits for agricultural businesses aiming to reduce their emissions and set other ESG targets.
“There is a set of KPIs set by agri sector and environmental professionals - like a drop-down menu customers can choose from, which would be relevant to their particular goals,” Coxhead says. “They would need to look at percentage-based improvements - ambitious targets above business as usual.
“BNZ then requires an independent audit to verify the customer’s baseline, and track their performance annually through the term of the loan, with pricing benefits available once evidence has been provided of meeting their annual on-farm KPIs.”
Now BNZ is launching a product for SMEs. The bank's Green Business Loan - a ‘use of proceeds’-based offering that will give discounts for lending with a green purpose - will be in market this month, Coxhead says. "Initially the loan will fit the transport, energy and agriculture sectors, with more to come moving forward.”
Win-win for bank, customers, planet
Coxhead says the way BNZ looks at sustainability these days is a far cry from when banks could claim they were going green when they reduced the carbon footprint of their corporate HQ, or chose not to deal with polluting companies.
“Underpinning the Net Zero Banking Alliance is a commitment to align the financed emissions in our lending and investment portfolios to net zero by 2050 or sooner.”
For banks that’s really the vast majority of their 'scope 3 emissions' - those emissions related to their whole supply chain, including customers, not just their own company.
“This makes sustainable finance an important tool to help drive change,” Coxhead says. “We can help support customers to transition their businesses, and that in turn helps the bank transition its portfolio.”
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