Insights: How food producers can leverage sustainability-linked financing

Sustainability-linked financing refers to lending at a discounted interest rate provided that meaningful targets are set across a range of environmental, social and governance criteria. If the targets are not achieved, the borrower incurs an interest rate penalty. By bringing in social and governance indicators, it is broader in scope than green finance, which tends to focus on climate action and environmental indicators.

Launched in 2017, the market has grown quickly, with businesses across all industry sectors under pressure from external and internal stakeholders to improve their green credentials.

Last year alone, over $700bn in sustainability-linked loans and bonds was issued, according to figures from Bloomberg.

From a sustainability standpoint, the global food system faces a contradiction. On the one hand, the industry provides employment (particularly youth employment) around the world, and with it the chance of sustainable economic growth for both emerging and developed economies. On the other hand, however, food production comes with an inevitable contribution to global greenhouse gas emissions and environmental degradation.

With this in mind, the food production industry is increasingly turning to sustainability-linked financing, as a way of mitigating its impact on the planet. Last year, 12 per cent of lending to the agri-food sector was sustainability-linked in some form.

The long supply chain associated with food production offers up a number of indicators that can be measured when putting in place sustainability-linked financing. A company’s carbon footprint can be reduced through switching to more efficient heating and cooling systems, as well as moving to a more fuel-efficient fleet for transportation. Companies can look to the three Rs – reduce, reuse, recycle – to cut down the amount of waste they send to landfill, and water use is another area that can be measured and targets set.

The ease of tracking different indicators can vary between different subsectors of the food production industry, with some parts of the supply chain more opaque than others. This has increased the importance of leveraging the appropriate technology, in order to receive the right data. Usually, no more than a handful of indicators will be used when setting up a sustainability-linked loan. Sucafina, an international coffee producer, for example, linked the interest rate it paid on one sustainable loan solely to the reduction of food waste, and solely to carbon reduction in the second.

Carbon reduction targets have also featured in sustainable financing from HSBC to fresh fruit and vegetable producers in Singapore (Sustenir) and the UK (DPS) in order to help both companies integrate vertical farming techniques into their production, leading to a 90 per cent reduction in CO2 emissions compared with traditional farming methods.

As inflation has risen around the world in recent months, so have interest rates in many developed and emerging markets, as governments seek to use monetary policy to tackle rising prices. Food producers looking to conventional borrowing will end up passing higher borrowing costs on to consumers – damaging at a time when global food prices are already rising due to the situation in Ukraine, rising energy prices and lingering supply chain constraints from the Covid-19 pandemic.

By using sustainability-linked financing, food producers can lock in lower borrowing rates while simultaneously reducing their impact on the environment and contributing to the communities in which they operate – a win-win situation. Greater use of sustainability-based financing is also a win-win situation for banks and other sustainable lenders, helping to make their lending portfolios more sustainable as they strive towards their own internal ESG targets. No surprise then, that HSBC has set aside $1tn worldwide to finance sustainable businesses and develop climate solutions.

Between early February and early March this year, oil and gas prices rose by around a third around the world, and have seesawed ever since thanks to the situation in Ukraine and other underlying geopolitical factors. The cost of energy generated from clean sources is less impacted by such shocks, making it more stable. Greater reliance on energy from clean sources will make the food production industry less susceptible to external factors – another benefit to sustainability-linked financing.

The risk to sustainability-linked finance is that the word “meaningful” is subjective; the mix of ESG indicators doesn’t allow for accurate comparison and may confuse lenders, and the size of the penalty if targets aren’t met is inconsistent and may not sufficiently motivate borrowers to hit their targets. Failing to address these challenges risks sustainability-linked markets becoming a way to greenwash finance, which will lead to a loss of confidence in this potentially important financial instrument.

Jeffrey Beyer, who is the managing director of UAE-based sustainability consultancy Zest Associates and one of the experts speaking at Gulfood Manufacturing — being held from November 8 to 12 — shared his recommendations on how to make sustainability-linked finance more robust in the face of the above-mentioned challenges.

Beyer recommends three improvements:

• ESG criteria should be disaggregated. It’s illogical to compare, e.g., a workplace health and safety goal with a greenhouse gas reduction goal. Disaggregation would create climate-linked, environment-linked, governance-linked and social-linked bonds and loans. This way, lenders know exactly what kinds of targets they’re supporting, and targets can be more easily compared between borrowers.
• The word “meaningful” should be better defined. In the case of greenhouse gas emissions, meaningful targets are helpfully defined by the Science-Based Targets Initiative, which offers sector-by-sector guidance and advises on the size and speed of targets that will prevent the worst effects of climate change. Similar approaches could be adopted for other metrics, for example, by aligning to the UN Sustainable Development Goals for social targets or the OECD for best-practice governance arrangements.
• Penalties for failing to meet targets should be strict and consistent. Tiny penalties are not motivating, and some sustainability-linked penalties have been as small as 1 basis point (0.01 per cent). This risks allowing borrowers to secure cheaper finance, then fail to hit their targets and get away with a financial ‘slap on the wrist’. Stronger, motivating penalties should be introduced to give firms incentives to hit their clearly-defined targets.

In conclusion then, sustainability-linked instruments have the potential to unlock hundreds of billions or even trillions of much-needed investment. They open up sustainability to all companies, including those in the food and beverage sector, and can help finance businesses to transform into greener, fairer, and better-run enterprises. It is critical to ensure this new and fast-growing financial instrument is robust, and lives up to its huge potential to deliver genuine improvements for communities, investors and the environment.

Mark Napier is the vice president – exhibitions at Dubai World Trade Centre