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The Rise of ESG in Aviation Financing Transactions

ACC's Director of Consulting, Rob Watts, reflects on the rise of sustainable investing, the growing importance of ESG in aviation financing and the implications for airlines and investors.

ESG stands for Environmental, Social and Governance, the three growing sustainability related factors that investors and financiers are increasingly giving more importance to in their due diligence and credit rating processes.

While an entity’s ESG standing and related performance was not traditionally a key factor in financing transactions, it is commanding greater importance in deals, with some experts believing it could become a significant contributor to successful deal-making in the near future.

What is driving the shift towards ESG in deal-making?

Governments, policy administrators and regulators are under increasing pressure to make good on their sustainability pledges. As a result, financial institutions and investors are actively pursuing business opportunities with entities (and on projects) that promote sustainability. This has led to financiers and investors offering ESG financing products to corporations that prioritise sustainability initiatives, measured by their ESG policy.

If corporations are to access these types of financing in the capital markets, they have to prioritise sustainability in their respective industry or undertake projects with an underlying ESG initiative.

For airlines, this may include tapping into green financing for renewing their fleets or investing in newer, more fuel-efficient aircraft; the underlying ESG initiative here is to reduce the airline’s carbon footprint by investing in more energy efficient technology.

The public is also increasingly ‘going green’, with consumer sentiment shifting towards corporations where sustainability is at the centre of their policy-making.

While there may be corporate leaders out there that argue ESG adaptation hasn’t yet gone mainstream in their respective industries, the shift in consumer sentiment, combined with the need to access ‘green’ capital markets, is forcing them to take notice of this emerging trend and step up their ESG initiatives and sustainability practices.

An increasing number of financiers and investors are introducing ESG in their due diligence and credit rating models, making this a key aspect of financing deals that airlines (like entities in many other industries) must be prepared for.


What is ESG?

Principal areas of consideration include:

Environmental – climate change, pollution, raw material use, energy efficiency and recycling practices. An example of an environmental factor for airlines includes carbon emissions from its fleet.

Social – employee rights, employee engagement and turnover, health and safety, satisfaction (both employee and customer), equality, transparency, gender and diversity, supply chain and procurement. An example of a social factor for an airline would include health and safety policy for its engineers working in the aircraft maintenance division or in the airline’s maintenance hangars.

Governance – management compensation, bribery, corruption, whistle blowing schemes and whistle blower protection, lobbying and political influence. An example of a governance factor for an airline would include dealing with regulators and safety auditors in a transparent manner.


Types of ESG Financing

Green & Social ESGs

Green ESGs are for those that require funds from lenders to be used for a specific sustainable purpose or project. For example, Apple’s transition to 100% recycled aluminium and drawing more power from renewables was funded by a green bond.

Funds used for purposes or projects falling under the ‘social’ category may be called Social ESGs instead of Green ESGs, however, the principle remains the same – the funds are utilised towards the specific project they are disbursed for.

Sustainability ESGs

Similar to Green and Social ESGs, these involve utilisation of funds for projects with a combination of green and social elements.

Sustainability-Linked ESGs

This pathway suits those that require the borrower to achieve certain ESG targets within its wider business, in exchange for pricing benefits. For example, Tesco was one of the first companies to tap this market, with a €750-million sustainability-linked bond in January, committing the supermarket chain to a 60% cut in greenhouse gas emissions by 2025.

Sustainability-Linked ESGs differ from the Green-Linked (or Social-Linked) ESG in the sense that they are not tied to a specific project. Rather the financing terms are linked to the borrower’s performance against sustainable performance targets. The borrower has pre-determined sustainability targets measured by pre-established KPIs. The performance of the borrower on those targets drives the financing terms / costs.


Growth in ESG Investing

ESG investing has seen steady growth in demand over the past decade. The first phase of sustainable investing began in 1995 when the first sustainable bonds were issued. In the initial few years, focus was on creating and formalising the foundations for sustainable financing.

Over the past five to seven years, we have been moving into what can be described as a true mainstream phase of ESG investing and growth. The Covid-19 pandemic has further accelerated this growth and focus towards ESG investing. The greatest impact of Covid-19 pandemic has been on Social ESGs (where funds are utilised towards social-oriented projects), mainly due to concerns about growing social inequities.

However, the pandemic has highlighted the need for developing societies that are resilient in nature and better positioned to withstand high-impact shocks related to macro-level factors, including health, safety and climate change.

As this becomes the central theme of a post-Covid world, we expect a rise in ESG instruments that target a broader range of sustainability objectives; and this is where the aviation industry and its role in the growth of ESG financing comes into play.

Aviation is one of the several industries that is under pressure to transition to a net zero concept and, as such, the role of Sustainability-Linked ESGs to enable such a transition cannot be emphasised enough.

In a recent sustainability financing and investing survey carried out by HSBC, close to 94% of respondents among borrowers said they disclose aspects of their ESG performance, and a similar portion said their capital providers care about such a disclosure.

Among investors, over half of the respondents said they have already adopted firm-wide policies on ESG investing. Another interesting, albeit expected response, was that 55% of borrowers view climate change as a threat over the next 10 years, whereas 76% of investors recognise it as one of the most serious challenges for humanity. 2,000 market participants were included in the survey, which was carried out recently – the full report can be accessed here.


ESG Investing – Aviation Outlook

Going forward, we expect there to be several drivers for ESG growth in the aviation industry, including the following:

Regulatory pressure

Regulation of environmental issues in aviation is likely to continue increasing via various multilateral frameworks – ICAO’s Carbon Offsetting and Reduction Scheme for International Aviation (CORSIA) is one such example. This increased regulation is consequently going to drive an increase in ESG initiatives tied to projects with an environmental / climate aspect (green bonds, green loans, sustainability linked ESGs etc.)

Examples include the French government’s €7 billion financial support package for Air France. The deal is reportedly conditional on the airline cutting carbon emissions and reducing domestic flights – by backing out of competition with domestic rail services.

The Dutch government’s proposed €2-4 billion support package for KLM requires the state-owned carrier to contribute to sustainability and noise-reduction initiatives, including the reduction of night flights and cutting CO2 emissions in line with CORSIA.

Conscious consumerism

The general public is becoming increasingly aware of social and environmental issues and which businesses are taking their role in sustainability seriously. An airline’s ESG initiatives, how they measure them and their ESG ratings are increasingly influencing customers’ buying decisions.

Access to ESG-oriented capital markets

While this point is a bit muted for now since ESG investing in aviation is still in its infancy, as it grows borrowers with certain ESG ratings will be able to access capital markets offering ESG-oriented financing and at better financing terms (which may be tied to future airline ESG performance) than conventional lending.

Covid-19 as a catalyst

As airlines look to emerge from the pandemic with leaner business models and more focused networks and fleets, they will automatically be well-positioned to tap into ESG financing. This is partly driven by the fact that many airlines, as part of their network and fleet restructuring, have brought forward the retirement of their older, less-efficient jets (e.g. B747s), focusing on leaner, newer and fuel-efficient technology to drive a reduction in their cost base. Airlines undergoing a fleet and network restructuring, therefore, have a good opportunity to keep ESG in their mind while performing this exercise and devising their future fleet plans.


ESG Due Diligence – The Process

ESG due diligence provides more insights into a company’s sustainability initiatives and will help investors make sound decisions in their credit rating assessments where ESG is a criterion.

While the framework of ESG still remains fairly unstructured and inconsistent, all financiers and investors agree that the issues being considered are tailored for every industry.

International financing institutions such as IFC do provide some guidelines addressing how ESG can be incorporated into due diligence and credit rating processes. It is up to each financial institution or investor to create a framework that works best for them and the corporation/industry being assessed.

Our guide below as to what a typical ESG due diligence process may involve, will provide more insight to investors looking to assess an airline’s ESG standing. While the below is depicted from the perspective of an investor or financier, as they will be driving the ESG due diligence process, it also provides some insight to airlines in terms of what they can expect from the ESG due diligence process.

ESG Due Diligence Services

Are you a financier or investor looking to expand your understanding of ESG factors affecting airlines and how to incorporate them in your credit analysis and due diligence process?

Are you an airline looking to tap into ESG-oriented capital markets and would like to better understand your readiness for an ESG due diligence? Or are you undergoing restructuring and would like to better understand how to devise your policy around ESG for keeping your sustainable financing options open in future?

As a provider of market leading solutions to the aviation industry across the globe, ACC Aviation is widening its portfolio of services to offer ESG due diligence and related advisory from its global office network spanning New York, London, Dubai, Addis Ababa, and Kuala Lumpur.

For more information about our complete range of services or to enquire about your airline’s specific requirements, get in touch or speak with a member of our team on +971 4 250 0373.

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