How can sustainability-linked finance deliver?

While ratchets are now widely included in term sheets, this often reflects optionality rather than execution. KPIs are frequently finalised late, deferred, or never activated. 

Even where they are agreed, many lack materiality to the borrower’s business, limiting their ability to drive meaningful behaviour change or strengthen credit quality.

This matters because private credit managers often have limited influence over borrower behaviour. SLMRs provide a practical way to link pricing to performance and reward progress, while supporting risk management, sponsor relationships, and fundraising with LPs. For sponsors and borrowers, they offer a route to lower financing costs while signalling disciplined sustainability management.

The defining challenge is therefore closing two gaps: between inclusion and activation, and between ambition and materiality. This requires clear internal ownership, credible KPI design, robust data, and early alignment across sponsors, co-lenders, and verifiers.

This paper sets out a practical roadmap to close these gaps and turn SLMRs from term sheet features into credible, decision useful pricing mechanisms.

The ratchet is tightening

Sustainability-linked margin ratchets (SLMRs) had their moment in the spotlight. Welcomed as a clever way to link sustainability performance to pricing by rewarding borrowers for meeting sustainability targets and giving lenders a visible proof point of ESG integration, they quickly became the mid-market darling of private credit.

That initial 2021-2022 boom was followed by growing scrutiny. At its peak, ESG-linked structures accounted for roughly 50% of European direct lending issuance in 2021, reflecting how rapidly sustainability-linked pricing mechanisms were adopted across the market. LPs, regulators, and the media began to call out weak structures, vague KPIs, and claims of sustainability outcomes that did not hold up under pressure. Some of those greenwashing accusations were justified: many ratchets lacked ambition, measurability, or meaningful consequences.

In response, some GPs quietly dropped the idea, citing complexity or cost, while others doubled down. However, the idea was not abandoned, but rather continued to be refined by a number of firms who were committed to credible SLMRs. Market data suggests that this group of lenders has become increasingly influential: the five most active European direct lenders accounted for roughly 55.9% of ESG-linked lending activity in 20253, according to Debtwire rankings. Rather than focusing on selling the merit of the concept, they worked to refine SLMRs. They developed clearer frameworks, strengthened governance, and coordinated earlier with sponsors, borrowers, co-lenders and verifiers. The focus shifted from marketing to meaning, using SLMRs as a genuine tool for engagement and sustainability progress rather than “ESG window dressing.”

While headline adoption has fallen, more recent reported uptake figures tell only part of the story. Across the market, many lenders now regularly include ESG or sustainabilitylinked ratchets in their term sheets, with portfolio coverage rates often cited between 60–80%.4 Yet inclusion in term sheets does not always mean follow-through. In practice, some ratchets remain symbolic, with KPIs finalised late or never formally activated, limiting their actual impact.

SLMRs are increasingly being used as a behavioural tool to influence borrower conduct, strengthen risk management, and meet investor expectations. What matters now is not how many loans reference a ratchet, but how many follow through with credible, measurable implementtation. When  designed thoughtfully, SLMRs move beyond symbolism to become mechanisms that drive genuine sustainability progress and unlock tangible value for both lenders and sponsors.