From sustainability-linked loans to transition finance: navigating the evolving landscape of green lending
The landscape of sustainable finance is undergoing significant changes, with sustainability-linked loans (SLLs) facing mounting challenges. Despite their initial promise as a tool for aligning financing with corporate environmental goals, SLLs have recently experienced declining demand and heightened scrutiny. Meanwhile, the concept of transition finance is emerging as a potential avenue for bridging the gap between sustainability goals and pragmatic corporate strategies.
In this article, we explore the current state of SLLs, the challenges they face, and the opportunities presented by transition finance. We also explain what transition finance is, highlighting how it supports industries on their journey towards sustainability. Additionally, we examine the implications of the Loan Market Association’s (LMA) recent publication of model clauses for SLLs and their potential impact on the Swedish and broader Nordic markets.
SLLs: A promising concept under pressure
SLLs were designed to incentivise borrowers to achieve sustainability targets by linking loan terms to key performance indicators (KPIs). However, recent market developments reveal several barriers to their continued growth:
- Credibility concerns:
Issues surrounding the robustness of KPIs and the risk of greenwashing have undermined confidence in SLLs. Borrowers and lenders alike face scepticism about the genuine impact of these instruments, with questions raised about whether they deliver meaningful environmental benefits.
- Regulatory scrutiny:
Financial regulators, concerned about market integrity, are calling for stricter oversight and more rigorous standards. This increased scrutiny, while essential for maintaining trust, has added complexity to SLL transactions.
- Economic challenges:
The complex documentation and verification processes associated with SLLs—coupled with modest pricing benefits—have deterred many borrowers. Companies often weigh these challenges against other, less burdensome financing options.
- Corporate commitment shifts:
Some businesses have scaled back their environmental targets due to economic pressures, reducing the demand for SLLs. This trend underscores the need for financing structures that accommodate varied levels of corporate ambition.
The Role of the LMA’s Model Clauses
The Loan Market Association’s recent publication of model clauses for SLLs represents a noteworthy development. By providing standardised documentation, the LMA aims to address some of the credibility and complexity concerns that have plagued the market. These clauses offer lenders and borrowers a framework for structuring SLLs with greater transparency and consistency.
Market feedback has been generally positive, with participants welcoming the effort to create a more consistent approach to SLL documentation. The clauses are viewed as an essential step towards improving market integrity and fostering trust. However, some commentators have noted that the model provisions are not a definitive standard but rather a starting point. The LMA itself has highlighted the need for ongoing adaptation of the clauses as the market evolves and consensus emerges. Additionally, extensive drafting notes have been provided to guide parties in tailoring the provisions to specific transactions, underlining the importance of case-by-case assessments.
In the Nordic context, where sustainability is a key focus, these model clauses could encourage market participants to re-engage with SLLs. One recent example is Epiroc, a Swedish industrial company, which secured a USD 150 million sustainability-linked loan from the Nordic Investment Bank in October 2024. This loan is tied to Epiroc’s ambitious climate goals, including a commitment to halve emissions by 2030.
However, the effectiveness of such efforts will depend on widespread adoption and continued focus on addressing underlying issues such as KPI robustness and greenwashing risks.
Market feedback has been generally positive, with participants welcoming the effort to create a more consistent approach to SLL documentation. The clauses are viewed as an essential step towards improving market integrity and fostering trust. However, some commentators have noted that the model provisions are not a definitive standard but rather a starting point. The LMA itself has highlighted the need for ongoing adaptation of the clauses as the market evolves and consensus emerges. Additionally, extensive drafting notes have been provided to guide parties in tailoring the provisions to specific transactions, underlining the importance of case-by-case assessments.
In the Nordic context, where sustainability is a key focus, these model clauses could encourage market participants to re-engage with SLLs. However, their effectiveness will depend on their adoption and the willingness of stakeholders to address underlying issues such as KPI robustness and greenwashing risks.
In the Nordic context, where sustainability is a key focus, these model clauses could encourage market participants to re-engage with SLLs. However, their effectiveness will depend on their adoption and the willingness of stakeholders to address underlying issues such as KPI robustness and greenwashing risks.
Transition Finance: A new frontier
Transition finance is a relatively new concept in the sustainable finance landscape, designed to address the unique challenges faced by high-carbon industries in their efforts to decarbonise. Unlike SLLs, which link financing to specific ESG goals, transition finance focuses on enabling companies to transform their operations in alignment with broader sustainability objectives.
A number of recent Swedish initiatives exemplify the principles of transition finance:
- Cemvision: This venture is focused on producing near-zero emission cement, reducing the carbon footprint of traditional cement production by up to 95%. Cemvision achieves this by utilising recycled raw materials and green electricity, aligning with the goals of transition finance to support the decarbonisation of high-emission industries.
- Northvolt: A leading battery manufacturer, Northvolt exemplifies the opportunities and challenges of industrial transition. With a $5 billion green loan secured in 2024 to expand its gigafactory and recycling operations, Northvolt demonstrates how transition finance can drive sustainable innovations in energy storage. However, the company has also faced production delays and financial hurdles, highlighting the complexities involved in scaling large-scale transition ventures.
- HYBRIT Project: A collaboration between SSAB, LKAB, and Vattenfall, the HYBRIT project seeks to revolutionise steel production by replacing traditional coal-based processes with green hydrogen. This pioneering initiative aims to eliminate carbon emissions in steelmaking, marking a significant milestone for the industry.
- Stegra (formerly H2 Green Steel): This venture is focused on producing steel with drastically reduced carbon emissions through innovative technology and renewable energy. Stegra represents a bold step towards the decarbonisation of one of the most energy-intensive industries.
These projects highlight how transition finance can enable groundbreaking progress in sectors that are critical to the global economy but face significant challenges in reducing their environmental impact.
What is Transition Finance?
Transition finance aims to support businesses and industries that are essential to the global economy but are also among the most difficult to decarbonise. These include sectors such as energy, steel, cement, and chemicals, which play a critical role in society yet face significant barriers to achieving net-zero emissions.
Key characteristics of transition finance include:
- Specificity of Purpose: Funds are directed toward clearly defined projects or activities that contribute to reducing carbon emissions or transitioning operations to more sustainable practices. Examples include upgrading facilities, adopting cleaner technologies, or building carbon capture systems.
- Framework Alignment: Projects financed through transition finance are often aligned with credible frameworks such as the Climate Transition Finance Handbook or industry-specific decarbonisation pathways.
- Incremental Progress: Transition finance recognises that industries with high emissions require a phased approach to sustainability. This allows for measurable, time-bound improvements rather than demanding immediate overhauls.
How does Transition Finance differ from SLLs?
While both SLLs and transition finance aim to promote sustainability, their approaches and target audiences differ significantly:
- Sector Focus: Transition finance is geared toward carbon-intensive industries, whereas SLLs are accessible to any business with measurable ESG goals.
- Use of Proceeds: Transition finance is project-specific, focusing on transformative initiatives, while SLL proceeds can be used for general corporate purposes.
- Incentives and Accountability: Transition finance often involves rigorous standards and detailed transition plans, ensuring that financed projects contribute to meaningful environmental progress.
Advantages of Transition Finance
Transition finance offers several advantages that make it a compelling option for borrowers and lenders alike:
- Inclusivity: By accommodating industries at different stages of their sustainability journey, transition finance ensures that hard-to-abate sectors are not excluded from the green finance ecosystem.
- Practicality: It supports realistic, incremental steps toward sustainability, recognising the complexities of transforming established industries.
- Credibility: With a focus on transparency and adherence to credible frameworks, transition finance can address concerns about greenwashing that have challenged instruments like SLLs.
Conclusion
Recent trends in sustainable finance highlights the importance of balancing ambition with realism. Sustainability-linked loans (SLLs) have faced challenges such as credibility concerns, regulatory scrutiny, and shifting corporate priorities, but they remain a valuable tool for incentivising sustainability in a wide range of sectors. Recent examples like Epiroc demonstrate that SLLs can still play a critical role in aligning financing with meaningful environmental outcomes.
At the same time, transition finance is emerging as a complementary approach, addressing the unique needs of industries that are harder to decarbonise. Swedish initiatives such as Cemvision, Northvolt, HYBRIT, and Stegra showcase how transition finance can drive transformative change in high-carbon sectors, supporting global sustainability goals. These examples highlight the immense potential of transition finance while also underscoring its complexities, as seen in Northvolt’s challenges with scaling operations.
However, the growing interest in transition finance also raises concerns about the risk of hype, where high expectations and large inflows of capital may outpace the readiness of some ventures to deliver measurable impact. Lessons from past investment cycles, such as the dot-com boom, remind us of the need for careful evaluation, robust standards, and a focus on tangible outcomes.
As the market evolves, collaboration among lenders, borrowers, and regulatory bodies will be key to refining these instruments and ensuring their effectiveness. By embracing both SLLs and transition finance, and by addressing the risks and opportunities inherent in each, stakeholders can contribute to meaningful environmental progress while fostering a sustainable and resilient financial system.
