ICMA on the Role of Commercial Paper in Sustainable Finance

Key Aspects

• Given its nature as a short term "rolling over" financing tool, commercial paper (CP) role in the sustainable financial market has challenges.
• The market developed two main types of sustainable CP: Use of Proceeds CP and Sustainability-Linked CP.
• ICMA recognizes CP’s potential to play an active role in issuers’ overall finance strategies and suggests recommendations to deal with the challenges presented by the nature of CPs.

Commercial Paper in Sustainable Finance

Sustainable finance is key for achieving the European Law objective of making Europe carbon neutral by 2050, as it can mobilize capital towards projects and activities that contribute to climate mitigation and adaptation, as well as other sustainability goals.

The International Capital Market Association (ICMA) has recently published a Paper on the role of commercial paper (CP) in the sustainable finance market. The paper identifies the challenges and opportunities of using CP as a sustainable financing instrument, categorizes the different types of sustainable CP, and provides best practice recommendations for issuers and investors.

CP is a short-term financing tool that allows highly rated issuers to borrow money from institutional investors for up to one year (most common tenor in Europe is 90 days, in Spain tenor can be up to 2 years), usually at a discount (in Spain CPs are always issued at a discount). CP is often used to fund operating expenses, working capital, and other short-term needs.

One of the main challenges of using CP for sustainable finance is that CP is a short-term product, while sustainable finance usually focuses on long-term projects and strategies. ICMA identifies that in line with the green and social bond market, the sustainable CP market developed two main products: Use of Proceeds CP and Sustainability-Linked CP and published high level recommendations in relation to the use of each of these products in the sustainable market context.

In relation to the main challenge of reconciling the short-term nature of CPs with sustainability long term goals, in relation to both products, ICMA suggests that issuers align their CP with their overall sustainability strategy and framework, and that issuers follow the core principles that govern the sustainable finance market, depending on whether they issue use-of-proceeds CP or sustainability-linked CP (i.e. respectively, the ICMA Green or Social Bonds Principles or the ICMA Sustainability-Linked Bonds Principles). 

Use of Proceeds CP

In relation to use of proceeds CP specifically, ICMA recommends these are embedded in the issuer´s sustainable financing framework by:

• Outlining how the CP aligns to the four core components of the Green or Social Bonds Principles;
• Explaining how the proceeds contribute to the issuer's sustainability strategy;
• Defining use of proceeds CP as an enabling funding tool for financing eligible green, social, or sustainable projects or activities; and
• Allowing all eligible green, social, or sustainable projects or activities to be financed by use of proceeds CP.

In line with the ICMA Green and Social Bonds Principles, ICMA provides recommendations in relation to the use of proceeds, management and tracking of those proceeds and reporting.

Use of proceeds: emphasis on flexibility and transparency. The end use of funds for this type of CP can be quite versatile, supporting various expenditures such as operating expenses, capital expenditures, project working capital, research and development, and the refinancing of short-term liabilities. Additionally, funds can be allocated towards maintaining sustainable assets, bridging to bond financing, or refinancing maturing CP with new issuances, as long as these expenditures align with the issuer’s sustainable financing framework and relate to eligible green, social, or sustainable projects or activities. When it comes to financing and refinancing, ICMA recommends issuers to aim for transparency by estimating the proportion of proceeds used for financing versus refinancing, identifying which eligible projects or activities may be refinanced, and providing clarity on the expected look-back period for refinancing purposes.

Management and tracking of proceeds: the recommendation is that the net proceeds, or an equivalent amount, should be appropriately tracked by the issuer. This tracking should be verified by the issuer in a manner consistent with the practices for green or social bonds under the issuer´s sustainable financing framework.

Reporting

Allocation reporting: due to the short-term nature and frequent refinancing of use of proceeds CP, ICMA recognizes that it is challenging to track allocations precisely. Therefore, allocation reporting should be (i) considered on a cumulative basis annually, using an aggregated portfolio approach under the issuer’s sustainable financing framework and (ii) reflect both the simple average and the highest amount of outstanding use of proceeds CP applied to eligible green, social, or sustainable projects or activities over the reporting period, compared against expenditures in the same period. The total use of proceeds CP expenditures should exceed this highest amount, rather than the average amount.

Impact reporting: should be incorporated into the overall impact reporting under the issuer´s sustainable financing framework and assessed in generic terms at least at the project portfolio level.

ICMA places emphasize on the fact issuers should ensure there is no double counting of eligible green, social or sustainable projects or activities and/or their impact between with any other type of outstanding sustainable financing and recommends the verification of the allocations by an independent external reviewer.

Sustainability-Linked Commercial Paper

As we have seen ICMA observes that the market for Sustainability-Linked CP generally adopts the ICMA Sustainability-Linked Bond Principles. Along these lines ICMA publishes recommendations in relation to the longevity of SPTs and KPIs horizons, the use of ESG ratings as KPIs and adequate penalties in case the established SPTs are not met within the allocated timeframe.

KPIs and SPTs: issuers should calibrate KPIs towards a shorter term to match the CP's duration, although this may not guarantee continuous investor engagement to verify target achievement. SPTs must be ambitious and represent significant improvements beyond "business as usual," which can be challenging to measure over short periods, potentially undermining their perceived ambition. To address this disconnect, ICMA advises issuing sustainability-linked CP within an organization-level sustainability-linked financing framework or linking it to the issuer's broader sustainability strategy. This alignment ensures that the CP contributes to achieving longer-term SPTs under the framework.

ESG ratings as KPIs: issuers can use ESG ratings as KPIs as long as they clarify whether they are targeting the overall ESG rating or specific components (E, S, or G). Due to varying methodologies, subjectivity, and potential regulatory constraints, issuers should explain why an ESG rating is the best indicator of their core business ESG challenges and disclose the type of rating used. However, issuers should be aware of their limited influence over ESG ratings and the lack of agreed market standards for such ratings. (Regulation on ESG rating providers is evolving in Europe, please refer to our Post | New EU Regulation on ESG Ratings: What You Need to Know).

Penalties: ICMA finds that financial penalties directly linked to Sustainability-Linked CP, such as coupon step-ups used in sustainability-linked bonds, are unsuitable due to CP's short-term nature. Challenges include the attribution and allocation of penalties to multiple investors over different periods, and the impossibility of penalty payments once the CP is redeemed before target assessment.  The two main structures in the market are: not being able to use the sustainability-linked designation, until targets are met again, or a financial penalty that involves making donations to relevant charities or NGOs. There is no consensus on whether these measures effectively incentivize target achievement.

The paper aims to foster a coherent understanding among market participants and promote transparency in the use of sustainable CP. It also highlights the need for further innovation and development of best practices to fully integrate CP into the sustainable finance market and ensure it effectively contributes to the European objective of becoming carbon neutral by 2050.