For one, the loans don’t restrict what companies can do with the funds. Instead, lenders agree to tie interest rates to certain ESG metrics. Corporations, in theory, stand to benefit from lower borrowing costs if they meet their goals, and face penalties if they fall short.

Banks also tend to keep revolving credit facilities on their balance sheets rather than distribute the risk to investors. Companies can tap them as needed, though they often leave them undrawn for years.

Paltry Penalties
It’s a relatively novel form of financing, especially in the U.S. About $93 billion of sustainability-linked loans have priced this year, or seven times the $13 billion arranged in all of 2020. Still, it’s only a fraction of the nearly $1.5 trillion of loans syndicated in the U.S. year-to-date, according to data compiled by Bloomberg.

Some industry watchers expect economic incentives to get more aggressive as the market develops. And to be sure, certain firms use them as part of a wider array of tools to help achieve (and convey to investors) their environmental and social objectives.

But in other cases, sustainability-linked loans have seemingly become a way for companies to tout their ESG bona fides while risking the absolute bare minimum, potentially adding to concerns about so-called greenwashing that have emerged in other areas of sustainable finance and attracted scrutiny from regulators.

Bloomberg used public filings and information obtained from companies to analyze 77 revolving credit facilities and term loans that included sustainability adjustments.

About 40% of the borrowers agreed to pay a penalty of five basis points if they failed to meet their targets in exchange for a five basis point discount if they achieved their goals -- a total swing of 10 basis points.

A pair of borrowers, Millicom International Cellular SA and Diana Shipping Inc., set the adjustments at 10 basis points in either direction.

At the opposite end of the spectrum, more than a quarter of firms had incentives that amounted to a single basis point if they drew their revolvers, like American Campus Communities did. When credit lines remain untapped, sustainability adjustments either don't apply or amount to one basis point at most.

“Most of the pricing adjustments upward or downward are tiny,” George Serafeim, a professor at Harvard Business School who focuses on corporate performance and social impact, said via email. “It seems to me more a symbolic gesture rather than a serious effort to price and embed in the contract climate risk.”