Scope-three and “neutral zone” highlight Cromwell’s SLL ambition

Deal sources highlight three factors as illustrative of Cromwell’s ambition in its financing update. The inclusion of a scope-three emissions reduction target and of annual interim KPIs throughout the life of the SLL speak to the borrower’s desire to deliver the most meaningful change. The addition of a “neutral zone” to the assessment – a range in which the borrower will receive neither a pricing discount nor a penalty – is an innovation that should help offset headline risk and thus allows the KPIs to aim high.

The SLL has three KPIs. The first focuses on scope-one and scope-two emissions reduction, the second on scope-three emissions reduction and the third on the gender pay gap. All three align with Cromwell’s corporate environmental, social and governance (ESG) targets as set out as objectives in its ESG Strategy document. The interim KPIs are in place for every financial year until financial year 2028.

The borrower says the emissions targets align with Cromwell’s goal of reaching net zero scope-one and scope-two emissions by 2035 and net zero scope-three emissions by 2045. The gender target contributes to Cromwell’s 2024 diversity objectives, which include reducing the company’s gender pay gap every year and achieving 40:40:20 gender diversity at all levels.

Cromwell will receive a margin discount if it achieves the annual targets, and pay more if it misses them. Deal sources are not disclosing the initial margin or the two-way adjustments.

The neutral zone adds nuance to the step-up and step-down thresholds. If Cromwell’s outcomes land within defined parameters close to its targets there will be no change to the loan pricing. “For each of the KPIs, we have a separate target that we need to hit to get the pricing benefit, a point where we get a pricing hit, and another zone where there is no pricing impact,” explains Stephanie Finemore, Cromwell’s Brisbane-based head of treasury.

The borrower argues that the addition of the neutral zone allows it to be more ambitious with its targets, by allowing an outcome in which it narrowly misses but is not punished for doing so. The penalty only arises in the event of a more significant miss. “Including a neutral zone reflects our ambition and the importance of achieving the goals we’ve set,” Finemore tells KangaNews.

All eight lenders have agreed to the terms of the facility and have opted in to the terms of the SLL schedule. However, because the terms are attached to an existing loan facility, lenders can opt in or out of the SLL loan schedule over the term on certain conditions.

The inclusion of scope-three emissions in Cromwell’s KPIs is notable given the complexities involved in its measurement. Scope-three emissions – indirect emissions generated by a company’s value chain – can be notoriously hard to track and measure, let alone reduce.

According to Environmental Finance Sustainable Loans Insight 2023, scope-three emissions KPIs were among the least common categories for SLLs between the second quarter of 2022 and the first quarter of 2023, being included in 20-30 transactions out of several hundred written over the six month period.

To inform its target, Cromwell used information outlined in its 2023 ESG report – released in January this year – which was the first time the borrower has published its full scope-three emissions inventory. Cromwell included 15 categories of scope-three emissions in its calculations, in line with the Greenhouse Gas Protocol. The company’s current scope-three emissions intensity is 186,590 tonnes of CO2 equivalent – more than 85 per cent of its total greenhouse gas emissions.

“Due to the nature of Cromwell’s activities, our scope-three footprint is by far our largest area of impact,” explains Lara Young, Cromwell’s London-based group head of ESG. “This is why we made a significant effort to disclose our full scope-three footprint in this year’s ESG report and it is also why we thought it was important to include a scope-three target in the SLL. Cromwell could absolutely blitz our scope-one and scope-two targets, but in reality this would be futile if we don’t also address scope-three.”

Tessa Dann, head of sustainable finance, Australia and New Zealand at Societe Generale in Sydney, adds: “Cromwell sets itself apart not only with this dual-structure loan but also by using a scope-three emissions target as part of the transaction. The inclusion of scope-three targets in SLLs and SLBs [sustainability-linked bonds] is still very limited but has been trending up over the last few years.”

Dann explains that scope-three targets are still rare because of the challenges of controlling emissions in the supply chain. In effect, even when borrowers can quantify their scope-three emissions – itself no straightforward task – many believe they have limited ability to change them.

As the owner of a large portfolio of property assets, most of Cromwell’s scope-three emissions come from tenants’ energy usage and waste. The large contribution scope-three emissions make to the borrower’s total and the fact that, as tenants, the emitters have reasonable proximity to Cromwell makes the situation more manageable, Dann adds. The publication of a full scope-three inventory in January provided a good overview of the levers available to create change.

While Cromwell’s circumstances were favourable for scope-three inclusion, Brendan Herriott, Brisbane-based director, sustainable finance at Commonwealth Bank of Australia, says there is growing interest from borrowers in this approach.

Herriott expects mandatory climate reporting – with climate disclosure obligations slated to start from 1 January 2025 for the largest entities, subject to legislation – will ramp up its inclusion. “We are not yet at the stage where scope-three targets are in every deal. But as borrowers get a better handle on their data they will hopefully feel more confident to set targets, and understand what management actions they can take and what impact these can make from a measurability perspective,” he adds.

Scope-three inclusion will not be possible for every borrower, though. Dann says it remains particularly challenging in some sectors, due to measurement difficulties or barriers to influencing change in the supply chain or because of technology issues. “Scope-three continues to be a huge challenge for all companies, whether it is a small fraction of overall emissions or the majority. Accurate measurement and the ability to influence change are critical,” she adds.

A big part of Cromwell’s scope-three plan is to encourage tenants to switch to renewable energy and to support them in reducing their landfill waste and contamination. On the energy side, Young acknowledges that much of the task will be achieved as Australia’s energy grid transitions. But Cromwell also plans to directly engage with tenants on potential activities where possible, such as, in some cases, to assist in to installing renewables onsite.

“If the Australian energy mix suddenly went backward or didn’t progress in line with what we expect, our approach will change – but it doesn’t mean our targets will be unachievable. In the interim, our tenants would require more onsite renewables, or we would need to find other alternative means to meet our targets,” Young explains. “We are relying on the Australian grid mix continuing to decarbonise in the way it’s meant to – but not entirely so.”

Meanwhile, the waste reduction strategy focuses on ensuring there is appropriate signage, facilities and education to dispose of and recycle waste properly. Cromwell also plans to provide help to tenants to investigate circular economy options to prevent waste in the first place.

All scope-three emissions measurement relies on Cromwell’s tenants’ own reporting. Young says some tenants are more mature in their ESG journeys, and part of Cromwell’s task will be to help those that are not as progressed to learn how to gather information.

Cromwell plans to share individual portions of the data it collates with tenants so they can benefit from it in their own ESG reporting. “There is no point in us all duplicating the same exercise,” Young notes. “Some tenants will have artificial intelligence AI that is tracking and analysing this information already, but others are less experienced.”

Tenant engagement could have its challenges but Young is confident engagement will grow over the loan’s lifespan. “Our KPI is out to 2028; we’re engaging with everyone now, but we don’t expect everyone to take it up straight away. There will be early adopters, some that are already in progress, and others that will take more time. We are not trying to get everyone to do this tomorrow – it is a phased approach,” she says.

Most importantly, Young says collaboration will be crucial. “We recognise that we can’t do this on our own. But there is greater maturity in understanding ESG, what the benefits are and what it looks like in practice. Our scope-three footprint is primarily made up of our tenants’ energy mix, which we can’t control but – having gone through the process ourselves – we can assist in guiding them through the transition to green power and renewables.”

Young says ambition was a priority when setting the loan terms. To decide the emissions targets, Cromwell calculated where it needed to be by 2028 to be on track for its 2035 and 2045 net zero goals and worked backward from there. Keeping the targets realistic but ambitious was a combination of ensuring data was robust and stress testing capacity for change, Young explains:

“It is a big jigsaw to make sure it all happens in a successful way. We have focused on our baseline ESG data over several years, and in this sense we consider that we have a robust foundation to work from – recent baselines so we are not comparing something from 1990 or 2000 when we are in 2024.”

Young adds: “Any relevant or realistic ESG target requires continual improvement. It needs us to keep stepping up, constantly re-evaluating our impact and the opportunities in front of us. We can’t just keep doing the same things year-on-year, so we are deliberately applying a dynamic approach.”

Finemore adds: “It will take a concerted effort in tenant engagement and investment from the business, and will also require a big focus across the business to achieve [the KPIs]. The point is, if we don’t continue to progress and we continue business as usual we won’t meet the targets.”