Good Loan, Bad Loan Sustainability-linked loans and the quality of KPIs

Abstract: Sustainability-linked loans (SLLs) have quickly grown to be the second-largest type of sustainable debt after green bonds. In theory, SLLs should incentivize borrowers to progress on sustainability objectives by linking the loan's interest margin to specific sustainability key performance indicators (KPIs). While the possibility of an inadequate selection of KPIs has repeatedly led to greenwashing concerns around SLL financing, little empirical work has been done to evaluate the quality of SLL KPIs in practice. Moreover, it is unclear if market participants differentiate between SLLs of high and low KPI quality. This study analyzes the KPI quality for a sample of listed borrowers using a scoring methodology based on the Sustainability-linked Loan Principles (SLLP) and subsequently investigates the stock market reaction to SLL announcements in an event study. The findings suggest considerable differences in KPI quality across borrowers and a weak incentivization of sustainability improvements on average. Furthermore, the event study results imply that investors only react positively to SLL announcements of high KPI quality, i.e., to the loans that convey a credible commitment to sustainability improvements. In contrast, no evidence suggesting a significant reaction to SLLs of low KPI quality is found. Lastly, this thesis finds that stock market participants are sensible to already small deviations in KPI design from the recommendations of the SLLP.