More CFOs Add Sustainability Targets to Corporate Loans

The loans, which include everyday financial instruments such as revolving credit facilities and term loans, allow finance chiefs to potentially reduce interest costs and showcase their sustainability efforts to investors, customers and employees.

The targets, which are usually based on internal ESG goals or external sustainability ratings, are supposed to be financially significant while also achievable, executives said. Companies have flexibility in how they use the loans, which typically have maturities of several years, unlike green bonds that raise funds for specific projects.

Corporate financing tied to sustainability commitments has surged in recent years. In addition to sustainability-linked loans, proceeds of U.S. corporate bonds issued with an ESG label have increased to $162.9 billion so far in 2021, compared with $100.5 billion during the same period in 2020 and $44.3 billion in 2019.

The rise of these bonds and loans comes amid a lack of global sustainability standards. Securities regulators in the U.S. are considering making climate-related reporting requirements mandatory, as investors pressure companies to demonstrate the steps they are taking to protect the environment.

Cigarette company Philip Morris International Inc. is in discussions with banks about taking out its first sustainability-linked loan, Chief Financial Officer Emmanuel Babeau said. The loan would replace a revolving credit facility and could be announced this month he said. The company declined to comment on the size of the loan and on pricing.

Philip Morris in August launched a financing framework with two targets that it would use for its sustainability-linked loan: generating more than half of its full-year net revenue by 2025 from so-called smoke-free products—such as its IQOS products that heat tobacco without burning it—which the company claims are less harmful for smokers than traditional cigarettes. That metric stood at 23.8% for the 2020 calendar year. The company also wants to sell those products in 100 markets by the end of 2025, up from 64 as of Dec. 31.

Philip Morris booked net revenue of about $7.59 billion during the period ended June 30, up about 14% from a year earlier. Net income was $2.17 billion, up about 12%.

“In everything we do, including how we finance the company, we put our ambition in becoming a smoke-free company at the core of what we do,” Mr. Babeau said.

Interest rates on sustainability-linked loans often go up or down by a fraction of a percentage point, depending on whether a company meets or misses its targets. Companies rely on third-party firms to assess their progress toward their self-established metrics, typically annually.

It is unclear how many companies have paid a higher interest rate for missing their targets so far, given that they don’t have to disclose this information, finance and sustainability executives said.

Wells Fargo is one of several big banks that offer sustainability-linked loans. “We’re responding to our assessment of our clients’ strategic priorities, and providing financing that supports those priorities,” said David Marks, head of Wells Fargo & Co.’s commercial capital business.

Wells Fargo together with other banks last month arranged a five-year, $1 billion asset-backed loan for cable manufacturer Southwire Co. The Carrollton, Ga.-based company, which is privately held, declined to share pricing details, but said the interest rate is tied to its objectives to eliminate by 2025 its so-called Scope 1 and Scope 2 emissions, which stem from its operations and the energy it buys.

Wells Fargo expects a portion of the Southwire loan to count toward the bank’s goal to deploy $500 billion in sustainable finance by 2030, according to a spokesman.

Whether the loans encourage companies to set ambitious targets or reward them for something they would have achieved anyway can be difficult to determine, said Krista Tukiainen, head of research for the nonprofit Climate Bonds Initiative.

“What we run the risk of is, you set targets that you know are foolproof for you,” Ms. Tukiainen said.

Aligned Data Centers LLC, a Dallas-based technology infrastructure company, in July increased the size of its sustainability-linked credit facility to $1.25 billion, up from the $1 billion it closed on last September. The company’s goals include increasing the usage of renewable energy in its data centers, conducting regular ESG assessments and ensuring worker safety on its construction sites, Chief Financial Officer Anubhav Raj said.

The company decided to take out a sustainability-linked loan because it made financial sense, Mr. Raj said. He declined to share details on pricing. The loan also helps Aligned demonstrate its ESG commitments to its customers, which include large technology companies.

“We think that’s attractive to them, and helps us win more business,” he said.

Write to Kristin Broughton at [email protected]