UK utility company Thames Water chose BNP Paribas Corporate and Institutional Banking to steer its positive incentive loan, the first such loan awarded to a UK business. By Edward Russell-Walling

Team February 2019

From left: Hiten Dave, Tina Andrews, Adrian Winburn, Emmanuelle Aubertel, Clare Webb, Mark Lynagh

In the past 18 months, sustainable finance has seen the rise of the positive incentive loan (PIL), which rewards borrowers who meet certain environmental, social and governance (ESG) metrics. Thames Water’s £1.4bn ($1.8bn) PIL was the first for a UK corporate, and was provided by a syndicate of banks and coordinated by BNP Paribas.

With a PIL structure, the interest paid on the loan is determined by whether or not the borrower achieves particular ESG goals. This might be a specific key performance indicator (KPI), or group of KPIs, often using metrics from the company’s sustainability report such as greenhouse gas emissions. It could also be an overall ESG score provided by an ESG rating agency.

If the borrower meets or beats the benchmark, it enjoys a discount on the loan’s margin. If not, it may have to pay a premium. Typically, a PIL has been added to a traditional corporate revolving credit facility (RCF) at the point of refinancing.

Holistic approach

The PIL is not to be confused with a green bond. To begin with, it is not a bond. A green bond’s proceeds must be spent on something specifically and certifiably green. Those from a PIL can be channelled into general corporate purposes.

“A PIL takes a holistic view, and is linked to overall sustainability performance,” explains Emmanuelle Aubertel, sustainable finance product structurer at BNP Paribas Corporate and Institutional Banking (CIB). “It’s an extremely interesting new product that allows corporates to align their sustainability strategy with their financing facilities, and it has enjoyed very strong pick-up.”

BNP Paribas has become a vocal champion of sustainable finance, though it did not invent the PIL. The first was a €1bn loan for Dutch technology group Philips, coordinated by ING and signed in April 2017. The interest rate was linked to Philips’ ESG rating, as determined by ratings provider Sustainalytics. If its rating goes up the interest rate goes down, and vice versa.

BNP Paribas has been quick to develop its own PIL franchise. Its landmark deal to date has been a €2bn RCF set up early in 2018 for French food group Danone.

Danone’s PIL financing costs depend on two separate outcomes: the firm’s average ESG rating from Sustainalytics and Vigeo-Eiris (another sustainable ratings agency), and its successful certification as a 'B Corporation', a business that meets the highest ESG standards.

Financing alignment

Thames Water is the UK’s biggest regional water company, with 15 million customers across London and the Thames Valley area. It was privatised in 1989, delisted in 2006 and is now owned by various institutional shareholders.

After a run of operational problems and governance issues, the company is under new management. “A focus of the new team is to build trust in the business as a responsible water and waste water company,” says Clare Webb, a managing director, corporate coverage, in BNP Paribas’ UK global banking division. “It established a green bond framework a year ago to underline its commitment to sustainability.”

The green bond framework was accompanied by a £705m green US private placement, and the company then began looking at other likely sources of green finance. The PIL option arose during discussions around the company’s existing £950m RCF, due to mature in 2022.

Thames Water wanted to refinance the RCF early, partly to take advantage of market conditions and partly to align its financing with the start of the next five-year regulatory pricing period in 2020. “The business plan will be validated by the regulator, Ofwat, in 2019,” says Ms Webb. “It wanted financing in place before then so that it had reassurance of operating/capital expenditure funding.”

The company was open to the possibility of combining the refinancing with a PIL, so it sat down with BNP Paribas to discuss what might be the most appropriate structure.

A PIL is a bespoke solution, Ms Aubertel notes, and will vary from company to company and industry to industry. “We need to make sure that the client is using the appropriate KPI, so we have very open discussions with them,” she says.

Identifying the right KPI opens the door to many other discussions. As the bankers like to point out, sustainability as a topic extends a long way beyond treasury. They were impressed by the fact that, alongside Thames Water’s treasury, its sustainability team was involved in discussions from the start.

In some companies, treasury only starts to think about sustainability when they get pushback from investor relations. “What is distinctive about Thames is the very close alignment of its treasury and sustainability/investor relations teams,” says Adrian Winburn, director, investment-grade finance, loans, at BNP Paribas CIB.

Plugging a gap

The deal was the first water company PIL to be worked on by BNP Paribas, so the bank had no comparable experience to draw upon. It quickly became apparent, however, that two of Thames Water’s key sustainability issues were infrastructure and adaptation to climate change.

Failing targets for leakage reduction have been one of the many criticisms faced by Thames Water in recent years, so infrastructure seemed to be a pertinent reference point for the company. That led to the ultimate selection of the Global Real Estate Sustainability Benchmark (Gresb) as the defining standard for the loan.

Amsterdam-based Gresb describes itself as “the ESG benchmark for real assets”, providing standardised and validated data to capital markets players. In 2018 it assessed 904 real estate funds and property companies, 75 infrastructure funds, 280 infrastructure assets and 25 debt portfolios. The resulting data is used by more than 75 institutional and retail investors representing more than $18,000bn in institutional capital, it says.

Passing the test

Gresb assesses the sustainability performance of two distinct groups of assets – real estate and infrastructure. In 2018 France’s Gecina, the largest European office real estate investment trust, signed a €150m PIL with ING France. The margin was linked to its Gresb real estate rating.

Thames Water has now become the second entity to enter into a Gresb-related PIL agreement, though it is the first linked to an infrastructure score. In the 2018 Gresb assessment scores for infrastructure, Thames Water ranked third in Europe out of 173 participants.

Gresb has built a reputation among investors, who are the driving force in ESG authentication, particularly now they are investing more in infrastructure and real estate. “We wanted a benchmark that was very credible,” says Ms Aubertel.

Once the structure of the PIL had been determined, Thames Water assembled a consortium of 13 banks, similar to the bank group it was replacing, and the facility was increased from £950m to £1.39bn. BNP Paribas co-ordinated the documentation.

Towards the end of the process, Thames Water decided that any financial gains resulting from the PIL would be donated to its own charitable fund. In 2017-18 the fund donated £103,395 to 21 charities and community groups across London and the Thames Valley region, relating to water and the environment. That decision struck a positive chord among the syndicate banks.

Risk reduction rewards

The attractions of a PIL to a borrower are fairly obvious, but what about the lenders? Mr Winburn provides one answer. “Incentivising sustainable finance is one of our stakeholders’ aims,” he says. “And this type of loan is now coming up in discussions with many of our clients.”

Ms Aubertel provides another when she says that bank analysis should not be purely financial analysis. “With PILs we are having a completely new discussion with our clients, broadening the parameters,” she says. “A client that performs well on all fronts is stronger and therefore less risky for us.”

In 2018, International Monetary Fund managing director Christine Lagarde called on business to do more to help achieve the UN’s Sustainable Development Goals. Too many companies failed to align the goal of improving ESG behaviour with financial performance targets, she said. PILs, which reward companies for good ESG behaviour, do exactly what she is asking for.

Change may be slow but institutions are heading in the right direction. “Sustainable finance is gradually entering the mainstream,” concludes Ms Aubertel. “Many banks are now trying to position themselves in the market.”

PLEASE ENTER YOUR DETAILS TO WATCH THIS VIDEO

All fields are mandatory

The Banker is a service from the Financial Times. The Financial Times Ltd takes your privacy seriously.

Choose how you want us to contact you.

Invites and Offers from The Banker

Receive exclusive personalised event invitations, carefully curated offers and promotions from The Banker



For more information about how we use your data, please refer to our privacy and cookie policies.

Terms and conditions

Join our community

The Banker on Twitter