Canadian Investors Take Note: Budding Green Loan Market Set to Ramp Up in 2018
May 14, 2018
Green bonds have been steadily gaining in popularity, becoming a high-profile instrument in capital markets and now green loans are set to ramp up in 2018.
Green loans are getting their own voluntary recommended guidelines to promote consistency in the emerging green loan market. Building on the internationally recognized Green Bond Principles of the International Capital Market Association (ICMA), the Loan Market Association (LMA) and the Asia Pacific Loan Market Association (APLMA) have recently published a set of Green Loan Principles (GLPs).
Furthermore, in April 2018, the Loan Syndications and Trading Association (LSTA) kicked off its own green loans initiative, which is expected to be aligned with the GLPs in hopes of encouraging more green loan activity in the U.S.
WHAT IS A GREEN LOAN?
The GLP define green loans as “any type of loan instrument made available exclusively to finance or re-finance, in whole or in part, new and/or existing green projects”. Green projects should provide clear environmental benefits that the borrower of the loan can assess and report on. The GLPs incorporate a non-exhaustive list of categories of green projects, including production and transmission of renewable energy, energy efficiency, clean transportation and green buildings that meet recognized standards or certifications.
Green loans are part of the broader trend towards green financing, and the goal in publishing the GLPs is to create a framework of market standards and guidelines for use by individual participants across the green loan market. The GLPs, which have been developed with the support of the ICMA, refer to, and in some cases mirror, the ICMA’s Green Bond Principles, which themselves promote transparency, disclosure and reporting in the green bond market.
WHAT MAKES A LOAN GREEN?
The key to what makes a loan “green”, according to the GLPs, is the use of proceeds of the loan for green projects (including other related and supporting expenditures, including research and development). In order to assess and monitor the use of proceeds throughout the life of the loan, the GLPs are based around four core components:
- Use of Proceeds
The use of green loan proceeds should be clearly described in the finance documents and eligible green projects should provide clear environmental benefits that will be assessed, and in some cases quantified, measured and reported, by the borrower to the lenders. Where the green loan forms a tranche of a loan facility, the proceeds should be credited to a separate account for tracking by the borrower.
- Process for Project Evaluation and Selection
Green Loan borrowers should clearly communicate to lenders the environmental sustainability objectives of the project, how they have determined that the project fits within the indicative categories set out for green projects, and the related eligibility criteria for the proposed project.
- Management of Proceeds
In order to maintain transparency, proceeds of the green loan should be credited to a dedicated account or otherwise tracked by the borrower. The LMA therefore encourages borrowers to implement an internal governance process to track the allocation of funds to eligible green projects.
The GLPs also focus on accountability, which is achieved by borrowers annually updating information on the use of proceeds and providing such information to lenders until the loan is fully drawn. For example, borrowers can provide a description of the projects for which the green loan proceeds were used and their expected impact. The GLPs recommend using qualitative performance indicators and quantitative performance measures, when appropriate. The private nature of the green loan market, versus the public nature of the green bond market, is taken into account in this component, with the GLPs suggesting that information “need only be provided to those institutions participating in the loan”.
The LMA also recommends a partial or full external review, when appropriate, to assess a borrower’s alignment with the GLPs, conducted by a third-party consultant, verifier, certification body or rating agency, or in some cases by a self-certified borrower.
As the core components demonstrate, compliance will be a significant aspect of the green loan framework put forth by the GLPs and will have the potential to increase transaction costs. Interested borrowers will have to consider the cost of such compliance against the potential goodwill obtained from participating in a green loan.
COMING TO CANADA?
Green bonds have been slower to take off in Canada despite interest from domestic investors. With the LSTA now working on a green loans initiative, interested parties in Canada will be monitoring the potential impact on the Canadian market.
We will continue to track the progress of the LSTA green loan initiative and its influence in Canada.
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