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Cost benefit for ESG loans in Europe yet to emerge

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Cost benefit for ESG loans in Europe yet to emerge

The European leveraged loan market has not yet seen a pricing differential between transactions that include a margin ratchet linked to environmental, social and governance-related criteria and those that do not, according to LCD data.

Looking across a comparable sample of euro-denominated transactions rated B flat — excluding repricings and add-ons — the data shows that having an ESG margin ratchet did not make a difference to new-issue spreads. Deals with an ESG margin ratchet had an average spread of E+395 in the last six months, and this level is virtually on par with the average spread for deals without an ESG component, which came in at E+396. (Note, LCD's sample of ESG-linked transactions included 11 deals, versus roughly 30 non-ESG deals in the data set).

"The benefit to issuers [with ESG-linked loan deals] is in the potential saving through the ratchet rather than the headline pricing itself," explains one market participant. "You're getting another saving on the margin at some point in the future, so I'm not surprised there's not a big price saving on the terms."

In the year to Oct. 13, some €22.6 billion of institutional loan transactions were completed with a margin ratchet linked to ESG-related criteria.

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This supply accounts for 22% of the total leveraged loan market volume seen in Europe so far this year, compared to less than 5% of the market in full year 2020.

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Popularity contest
The popularity of ESG-linked deals has not overcome some market participants' cynicism about the product, which is perhaps understandable, given how new the structure still is. Some sources have said they would prefer to see a punitive-only margin step-up, without the potential benefit of a margin step-down if an issuer hits its own targets, which would bring the product in line with coupon step-ups on offer in the bond market. Meanwhile, others want to see more standardization on how issuers structure, report on and test their ESG-related targets.

However, market participants note that the structure will develop and grow over time and that the market is unlikely to see the product's final form in these early stages, as the buildup phase over its introduction is still in play. "It's a gimmick at this moment in time," said one investor of ESG loan structures. "I'm hoping it's going to be here to stay and I believe it's a good thing, but at the moment it's a bit of a fad that everybody's excited about."

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Secondary consideration
In the secondary market for European loans, meanwhile, the sample size of facilities with an ESG ratchet is still relatively thin in a mid-20s context (based on pricing provided by IHS Markit). Again, pricing here is not suggesting any differential for ESG-related deals, with the average bid of this cohort very close to the average bid of all 2021-vintage deals tracked by the S&P European Leveraged Loan Index.

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In the European high-yield bond space, LCD tracked €15 billion of green, sustainability, and sustainability-linked issuance in the year through Oct. 13, which accounts for 14% of all high-yield activity. By count, the share of bonds with an ESG component rose to 17% this year, up sharply from just 2% in the prior two years.

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Note: For details on leveraged finance transactions with an ESG component, see LCD's ESG Leveraged Finance Tracker, a comprehensive Excel file that tracks new-issue loans and high-yield bonds in the U.S. and Europe that have an ESG component. The ESG Tracker is based on LCD News reporting, combined with transaction details from LCD's proprietary leveraged finance database. U.S. Research subscribers can access the file via this link, while European Research subscribers can access it here.