In the vast world of green banking, there is a rising prevalence of a unique mechanism called transition loans, a financing instrument that supports transitions to sustainable practices. Currently, green loans dominate buzz around sustainable lending, but transition loans are entering the market.
According to the IPSF Transition Finance Report, investors prefer the coverage of the whole entity, not just a specific project or initiative. Green loans are project-specific, while transition loans are designed to support a company's overall transition to sustainable practices. This means that transition loans require companies to develop specific sustainability goals and are evaluated based on their progress towards achieving those goals, rather than just the success of a particular project. Additionally, transition loans are considered to be less risky for banks, as they can evaluate lending rates on a case-by-case basis. “Investors favour coverage of the whole entity. For example, investors in a use-of-proceeds bond financing new renewable energy generation facilities issued by a predominantly fossil fuel energy generation company often look for broader information and evidence of the issuer’s company-wide transition to give some assurance that the green/ transition loan or bond is not greenwashing ongoing harmful activities.” (IPSF Transition Finance Report, 2022, p.36)
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The IPSF Transition Finance Report recommends that companies set goals that are aligned with the UN Sustainable Development Goals and that are measurable and time-bound. These goals should also be communicated transparently to investors and other stakeholders.
Here, AVIVA Investors Real Assets provides a framework for Sustainable Transition Loan, which focuses on four SDGs: SDG 7 - Affordable and Clean Energy, SDG 9 - Industry Innovation and Infrastructure, SDG 11 - Sustainable Cities and Communities, and SDG 13 - Climate Action. For each goal, eligible KPIs are set, such as "Improvement in energy efficiency through transition to EPC rating B or higher."
In Europe the situation is more straightforward with the help of the EU Taxonomy. e.g., for the same goal of energy efficiency, a company may use the EU Taxonomy’s criteria for ‘Building renovation’ (8.2): ‘leads to a reduction of primary energy demand (PED) of at least 30 %’
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Another example, in this link, ABN AMRO bank provided a sustainable loan to Farm Dairy and established a sustainability goal together: reducing the amount of energy consumption for processing 1,000 liters of raw milk. Farm Dairy used this loan to finance the cost of building an energy-neutral cooling cell and filling hall, which includes solar panels and insulation.
We already mentioned ABN AMRO bank, the third largest Dutch bank, that recently announced sustainable transition loans for small to medium enterprises (SMEs). ABN AMRO’s SME clients can now take out loans from €1-25 million towards sustainable goals. Every year the company performance is examined comparing to the annual target. If the company meet the goals the interest rate for the next year is reduced by 30 basis points, if not, the bank will add a 15 basis point markup for the next year.
<aside> 💡 Read more about the European efforts to improve green banking through our EU ESG Rating Proposal Article
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