Throughout the aviation sector, companies are integrating sustainability in all aspects of their business. That’s now true for aircraft leasing, where new green finance streams are opening up to incentivise more sustainable aviation fleet decisionmaking. After Pegasus Airlines closed the first ever sustainability-linked aircraft-secured term loan, we sat down with Barbaros Kubatoğlu, the airline’s chief financial officer, to talk details.
“This is an aircraft-secured UK Export Finance-supported loan for the financing of ten new Airbus A321neo aircraft,” Kubatoğlu tells us. “The loan is applied for the new generation, fuel-efficient CFM LEAP-powered and less-CO2-emitting Airbus A321neo aircraft financing.”
As part of the loan package, the Türkiye-based airline committed to two standardised environmental targets as part of the financing’s covenants, which links cost to the fulfilment of those targets.
“Although the initiation of the sustainable financing market only dates back one and a half decades — we can refer to The World Bank’s ‘Green Bond’ issuance in 2008 — it is fair to say that demand for sustainable finance instruments is growing rapidly,” Kubatoğlu explains. “We also believe that sustainable financing structures will become conventional in the foreseeable future, as opposed to merely opportunistic measures.”
Indeed, says Kubatoğlu, “we have noticed that financing resources are slightly scarce, especially for the jurisdictions that we operate in. Given the new banking system regulations, we believe that sustainability-linked financing structures may become mandatory rather than a ‘nice to have’ benefit.”
Developing the taxonomy of sustainable finance is a key prerequisite
A key part of developing sustainable finance is to determine what is, indeed, sustainable. As a recent report from Norton Rose Fulbright states, creating a sustainability classification, or taxonomy, is “an important step to facilitate the use of private capital to support the transition of the aviation industry to the low carbon economy. Greater certainty for lessors, financiers and airlines as to what constitutes a sustainable investment in the sector is to be welcomed.”
However, as the report notes, “a delicate balance needs to be struck between establishing sufficiently stringent targets to avoid accusations of ‘greenwashing’ and ensuring that those targets are achievable and workable in view of the technological constraints of the sector.”
The European Union’s approach on creating a sustainable taxonomy is among the most advanced, with the European Commission’s Platform on Sustainable Finance permanent expert group receiving its second mandate in February 2023.
Among other work, the group proposed a set of screening criteria [PDF] across industry, with four out of the five transport categories covering aviation:
- manufacturing of aircraft
- leasing of aircraft
- passenger and freight air transport
- air transportation ground handling operations
Crucially, the group highlights that, while aviation is not itself inherently sustainable at this point in time, it is what is known as a ‘transitional activity’ under Article 10(2) of EU Regulation EU 2020/852. In essence, this is economic activity where there is no “technologically and economically feasible low-carbon alternative” but where other criteria are met. Those criteria include having best-in-sector emissions levels, supporting climate-neutral economic transition by phasing out emissions (especially from fossil fuels), not blocking low-carbon alternatives, and not locking in carbon-intensive assets.
As a result, the Platform on Sustainable Finance says, “Therefore, screening criteria for aviation as a transition activity need to achieve three things: (1) incentivise the replacement of old, less efficient aircraft with new, more efficient ones without contributing to fleet expansion; (2) accelerate the development and market introduction of increasingly efficient aircraft without compromising the development of zero-exhaust CO2 emission breakthrough technologies; (3) incentivise the replacement of fossil jet fuel with sustainable aviation fuels, including the technical readiness of the aircraft fleet to operate with high blending ratios.”
Notes the report, “For leasing companies, a decommissioning (permanent removal from service) or selling rule requires that the company proves that an old, non-taxonomy compliant aircraft was permanently removed or left its fleet to make a new, more efficient one eligible. In order to avoid companies using the taxonomy to write off aircraft investments currently not flying but parked in long term storage facilities, this decommissioning rule requires the decommissioned aircraft have been in service at least 6 months before the date of decommissioning. Leasing of aircraft should take into account previous efforts to improve the energy performance of fleets but also ensure that fleet expansion and overall growth in CO2 emissions that has occurred before the entry into force of the criteria is not considered as taxonomy compliant.”
Meshing aviation sustainability and finance is a complicated challenge
Within the aviation market, Pegasus’ Barbaros Kubatoğlu explains, “we considered a sustainability-linked aircraft secured loan would suit our long-term commitments. As far as we know, this sustainability linked loan is the first global export credit agency-backed aircraft finance structure.”
Part of the persuasiveness of the finance structure is that cost benefits are provided up front, but must be maintained during the life of the transaction by achieving the sustainability targets specified within the deal.
“We signed the loan at the beginning of 2022, with all ten aircraft delivered by the end of the year,” Kubatoğlu notes. “As soon as the Second Party Opinion Provider confirmed the KPI alignment, the Sustainability Linked Loan structure was approved by UK Export Finance on 22 December 2022. The terms are indexed on future achievements of two sustainability-linked Key Performance Indicators: flight carbon intensity and gender diversity in management positions.”
Those indicators are measured by flight related average annual carbon emissions by revenue passenger per kilometre, and by the airline’s female-to-male ratio in leadership positions, respectively. Both internal reporting and independent auditors monitor progress.
Throughout, Pegasus’ ‘Digital Airline’ strategy is woven into the work it does on sustainability, bringing direct and indirect benefits to the carrier.
“We take advantage of technology in every process,” says Kubatoğlu. “Digitalisation plays an important role in the continuous improvement of operations, and our diligent cost management, and also contributes to our efforts in the sustainability journey. We believe that our societal impact thrives from our low-cost network carrier business model and our digital airline promise.”
Published 25 May 2023
Image courtesy of Airbus Media Centre
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