ESG the Divestment Conundrum

Next phase in the green revolution

The provision of sustainable finance and funding of renewables projects is a key component in how banks and other wholesale lenders are helping to tackle the global fight against climate change. Over recent years we have seen real progress made, both at a national level (with ambitious target setting) and amongst banks and other lenders, with various policies set which enshrine ESG commitments both in terms of lending targets and carbon emissions linked to said lending.

However, if climate targets are to be met, the origination of ESG-aligned assets on its own will not be sufficient. How non-"green" assets are funded or managed will be key to the transformation of the economy into a sustainable and resilient one and delivery of a 1.5 degree pathway. If we consider the evidence of the last few years, the transition will certainly not be a smooth one.

Investment in non-aligned assets continues

The Banking on Climate Chaos report, published by a coalition of civil society groups on 30 March 2022, contended that the banking community has channelled more than US$4.6trn of financing to the fossil fuels sector in the six years since the Paris Agreement was adopted in 2016.

• A good deal of this may well be transition related but some will not be.
• Of those assets that are currently non-aligned, a portion will no doubt come to be seen as transition related.
• Of those assets that remain some will become 'stranded assets' although many may well retain economic viability in the near term.

What we can be sure of is lending to non ESG-aligned assets will continue for now – who provides such funding may well change as banks and mainstream lenders look to exit such assets to ensure delivery on the ambitious targets referred to above.

The question is how to what to do with the financings associated with existing non-aligned assets - manage out, or sell and if selling, how to sell - the Divestment Conundrum.

Managing Out

Influential pressure groups will continue to call for non-aligned lending to cease but such a move, or perhaps more accurately, the timing of such a move will need to be debated. In the midst of an energy crisis, there will, quite rightly, continue to be a healthy debate between advocates of rapid shutdown versus 'staying engaged' and influencing the transition and semi-transition process of brown assets/companies .

Divestment Conundrum

How to sell?

Should lenders choose to focus on divestment of these loans, rather than managing their exposure to non ESG-aligned assets, how should they approach the process?

Banks with larger exposures (and judging by the figures above, there will be more than a few of them) may well set up specialist teams to ensure greater focus and expedience in divesting such assets.

The secondary loan market could be used but such an approach is probably for those banks looking to be opportunistic or with minimal exposure.

If lenders are serious about divestment they will need to move loans at pace. We would expect non-ESG-aligned loans to be bundled up on an asset-specific basis and sold as portfolios, not dissimilar to the approach seen at times in the Non-Performing Loan markets over the past few years . Portfolio sales will certainly move the dial more rapidly for banks seeking to deliver on promises and achieve targets.

Our recent experience, talking across buy and sell side suggests there would be appetite and interest in this approach.

Who will buy?

Some stakeholders will call for all non ESG-aligned lending to cease, arguing that this is the only way to tackle the challenge of climate change and, certain banks/lenders may not want to fund certain assets, but the reality is that the market continues to see activity and banks have to manage their exposure as discussed above.

These non-ESG aligned assets are not going to cease to exist but do need to transition. In a transition or run-off stage they still have a key role to play across the economy.

In our now highly liquid multi-layered debt market, there is no doubt that new lenders will arrive, either in the form of niche lenders and funds or other vehicles. How they alter the market, how they obtain, price and fund the assets will be an interesting process, as will how they deal with public perception, but arrive they will.

How Ashurst can help

In the sustainable finance market, we act for borrowers, lenders, arrangers and investors across a broad range of financing transactions. In the secondary trading market, our clients include sell-side banks, investors, servicers and debt-on-debt providers in market-formative transactions. We have extensive experience in delivering complex portfolio transactions.

Please get in touch if you are looking for advice on any aspect of sustainable investment and development, using portfolio transaction structures or otherwise.

With special thanks to Sarah Curry for her contribution.