Social and Sustainability-Linked Loans Overview

Social Loans

• Exclusively for financing or refinancing eligible social projects.
• Eligible projects include affordable housing and basic infrastructure.
• Offer positive impact on target populations and help deliver UN Sustainable Development Goals (SDGs).
• Four core components:
  • Use of proceeds
  • Proceeds for project evaluation and selection
  • Management of proceeds
  • Reporting

Sustainability-Linked Loans (SLLs)

• No specific projects, used for general purposes.
• Borrowers aim to achieve quantifiable sustainability performance targets (SPTs).
• Five core components:
  • Selection of KPIs: Relevant, quantifiable, and benchmarkable.
  • Calibration of SPTs: Based on recent performance and benchmarking.
  • Loan characteristics: Financial incentives tied to SPT achievement (e.g., interest rate reduction).
  • Reporting: At least once per year.
  • Verification: External and independent verification of borrower performance.

Green Bonds

• ICMA (International Capital Markets Association) sets standards.
• Core components and transparency similar to green loans.
• Transparency components:
  • Green bond frameworks: Accessible to investors (e.g., website).
  • External reviews: Providers review pre-issuance.

Green Loan vs. Green Bond

• Financing sources: Green loans use banks, green bonds use individuals or asset managers.
• Amount: Green bonds typically larger than green loans.
• Interest rate: Green loans typically floating, green bonds typically fixed.
• Maturity: Green bonds typically have longer maturity than green loans.
• Eligible green project determination: Negotiated between bank and borrower for green loans; determined by issuer for green bonds.
• Management of proceeds: Green loans transfer funds to borrower upon project eligibility; temporary non-green usage might exist for green bonds.
• Use of external reviews: More common for green bonds.
• Framework: Only green bonds have dedicated frameworks.

Social Bonds

• Similar to green bonds with additional transparency components.

Sustainability Bonds

• Finance or refinance both green and social projects.
• Four core components.

Sustainability-Linked Bonds

• Similar to SLLs with five core components.
• If SPTs are not met, a penalty of increased interest rate (step-up coupon) is applied.

Global Sustainable Investment Overview

• Europe and the US have the highest sustainable investment levels.
• ESG Integration, Value-based, and Engagement are top investment strategies.
• Strategies are not mutually exclusive, but combining them limits investment options.
• Retail investors accounted for 25% of total sustainable assets in 2018.
• Public equity is the main category for sustainable investment.
• Investment strategies vary by region:
  • Europe: Engagement
  • US: ESG Integration
  • Japan: ESG Integration

ESG Strategies

• Value-based exclusions: Industry-dependent, exclude based on percentage of income from negative activities for conglomerates.
• Norm-based exclusions: Aligned with UN principles on human rights, labor rights, corruption, etc.
• Best-in-class: Uses ESG scores for exclusion, typically active equity strategies with large-cap companies.
• Thematic investment: Focuses on specific themes, typically active equity strategies with small to mid-cap companies.
• ESG Integration: Integrates ESG aspects into traditional financial management, considering ESG factors in cash flow forecasting.
• Impact Investing: Aims for positive societal impact along with financial returns, across asset classes, mostly listed equities and bonds.

Engagement and Proxy

• Interactions between investors and investees.
• Top 3 investor engagement priorities:
  • Climate risk and energy transitions
  • Workforce and board diversity
  • Strategic workforce issues beyond diversity (e.g., AI, machine learning, ESG, data analytics).
• Management dialogue: Shareholder letters, etc.

ESG Disclosure Benefits and Costs

• Reduces information asymmetry between investors and companies.
• Facilitates monitoring of ESG KPIs, performance, and targets (SLL, SLB).
• Time and financial cost associated with disclosure.
• Avoiding misrepresentation in disclosure is crucial.

Voluntary vs. Mandatory Regimes

• Result of the global financial crisis.
• Significant information gaps exist in reports, with organizations like the World Bank or IMF focusing on risks and future development.

TCFD (Task Force on Climate-Related Financial Disclosure)

• Four pillars:
  • Governance
  • Strategy
  • Risk management
  • Metrics and targets

ISSB (International Sustainability Standards Board)

• IFRS Accounting Standards are equally important as IFRS Sustainability Disclosure Standards.
• Four pillars align with TCFD.
• IFRS S1 is sustainability-related, while S2 is climate-related.

HKEX ESG Reporting

• 2016: Upgrades general disclosures to "comply or explain" provisions.
• 2025: Mandate climate-related information in ESG reports.
• Applies to Main Board Listed (large-cap) and GEM Listed (small to mid-cap) companies.
• Two disclosure levels:
  • Board-level oversight
  • ESG working group (senior management)

Reporting Boundaries

• Determines which subsidiaries to include in ESG reporting.
• Approaches:
  • Following the scope used in annual reports
  • Financial threshold (e.g., revenue percentage) or risk level
  • Different scopes for different aspects/provisions

Materiality Assessment

• Keystone reporting principle.
• Internal assessment conducted by senior or key managers.
• Materiality aspects vary by location, industry, and other factors.
• Stakeholders: Entities affected by and impacting the issuer's actions.
• Materiality matrix:
  • Double materiality:
    • Internal (on business)
    • External (on stakeholders)