3 Reasons Banks Fear ESG Laggards

How lenders respond to a company’s request for financial assistance is somewhat driven by the applicant’s environmental, social, and governance (ESG) track record. Borrowers require financial capital in order to purchase equipment or new premises in which to produce its goods or services. Some of these capital improvements may be for pollution prevention equipment to comply with tougher environmental regulations, with energy-saving retrofits, for water conservation and treatment, or for new green production lines. Some of the loans may have nothing to do with green projects. Regardless, one cold reality applies to any loan request: Your ESG track record can be a stumbling block.

Access to capital is a challenge. Credit is still tight following the recession. Banks are tightening their requirements for loans and asking for more extensive disclosure about the applicants’ ESG policies, management systems, track record, and stakeholder relationships to help them assess environmental and social risk. There are three primary reasons banks care.

First, environmental practices influence the solvency of borrowing firms and may expose them to expensive legal, reputational, and regulatory risks. Lenders want to know if a borrower might be hit with costly fines, cleanup costs, and business restrictions which could impact its ability to repay outstanding loans.

Second, lenders want to ensure they are not stuck with the borrower’s liabilities. If the borrowing company defaults on its loan, the lender may have to seize the company’s assets that were used to secure the loan. If it seizes them, it owns them and is then directly liable for the cost of cleaning up any of the company’s environmental pollution, remediating contaminated land, and preventing further environmental damage.

Third, lenders are also wary of risks to their own reputations if the public perceives they are abetting irresponsible corporate behavior. This potential guilt by association leads to prolonged due diligence for potential environmental and social liabilities associated with the project or the borrower. This can delay financing for projects that may have significant environmental or social impacts, or render them ineligible for financing. Wells Fargo, Credit Suisse, Morgan Stanley, JPMorgan Chase, Bank of America and Citibank are now leery of lending to coal companies involved in mountaintop removal. HSBC has curtailed its relationships with some producers of palm oil, which is often linked to deforestation in developing countries. The Dutch lender Rabobank has applied a nine-point checklist of conditions for would-be oil and gas borrowers: the list includes commitments to improve environmental performance and protect water quality.

For these three reasons, laggard companies with poor ESG track records may find they pay a higher rate for their borrowed capital. Exemplary companies may enjoy a preferred rate. In my next blog, we’ll explore the size of this spread.

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Bob