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Finastra ESG Service Seeks to Automate ESG Loan Premia Calculation for Banks

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Loan pricing is a complicated business that’s being given an added shot of complexity by the requirement that borrowers’ ESG-linked performance be factored into the calculations.

It’s a challenge that financial technology provider Finastra has sought to solve with a new “standalone” solution to complement its widely used Loan IQ corporate lending servicing system. The Finastra ESG Service pulls in data on a borrower’s sustainability linked key performance indicators (KPIs) to more accurately price sustainability linked loans (SLLs).

In the absence of global standards on what factors to consider when calculating ESG premia, Finastra’s platform captures Sustainability Performance Targets (SPTs) and tests KPI data against them. In this way it also helps banks create ESG margin and commitment fee ratchets – provisions to lower the premia when progress is made towards those SPTs.

“ESG green financing is adding an extra layer of complexity to how transactions are priced and monitored,” Simon Thorogood, Finastra’s senior director of corporate and syndicated lending, told ESG Insight. “For many banks today, capturing KPI parameters and linking them to different ESG margin ratchets requires manual processes and dedicated resources. We built this tool to allow banks to easily capture that all in one place.”

Incentivising Change

Banks, like all financial companies, are under growing customer and regulatory pressure to improve their ESG performance. In the same way that established financial regulations in Europe require asset and fund managers to include the ESG profile of their investments in their own assessments, so banks must do the same with loans and bonds that they create.

Unlike green loans, which are priced according to the sustainability of the project or activity that the loan proceeds will fund, SLL prices reflect the sustainability risk of borrowers, regardless of the intended use of the proceeds of their loans. SPTs are agreed in the loan documentation to incentivise companies to improve their ESG performance.

Finastra’s ESG Service is a cloud-native SaaS application that uses service-oriented APIs. It’s automated to pull banks’ own data into its calculations of the ESG-linked premia charged in loans’ total interest rates.

“The idea is to have a product that captures KPIs and automatically generates the change in ESG margin, then feeds that out to the back-office systems,” said Thorogood, adding that the Finastra ESG Service could also be used to price corporate bonds and other credits.

Banking Evolution

Thorogood said that tools such as the ESG Service are necessary for banks, which are only just bedding in new globally fragmented risk-free reference rates following the demise of the LIBOR regime.

“What we’re seeing is the rise of KPIs driving some of those pricing elements that the corporates need to adhere to based on pre-defined agreements with their lending banks and syndicate banks,” he said.

Calculating ESG premia and ratchets is a delicate operation. Set them too low and the purpose of the exercise – to encourage more sustainable operations and business by the borrower – could be missed. If the penalties for not meeting SPTs are less costly than putting a sustainability transformation plan in place, then the incentive is lost.

Set them too high, however, and they may be impossible to meet, or the bank may be accused of profiteering by making it difficult for borrowers to reach the goals that will lower their interest rates.

Without standardisation, the KPIs to be considered in SLLs are generally determined by the kind of relationship the bank has with the borrower. But that can appear open to abuse and attract accusations of greenwashing if the SPTs are too lenient.

Thorogood said that the standardisation of KPIs would go some way to eliminating those risks, but regulators are at differing stages in their definitions.  In the meantime, he said that Finastra’s ESG Service will be continuously updated, possibly with the involvement of other fintechs, to provide the basis for the banks’ integration of regulatory frameworks when they are introduced.

“Standardisation may still be some way off yet but we’re looking to develop the tool to bring the standard KPI frameworks in so that everyone can automate the choice of the right KPI, the data pass-through to the back-office reporting teams and the resulting annual certification,” he said.

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