Lending Market Sets Sights on Sustainability Linked Loans
April 2, 2019
Building on the internationally recognized Green Loan Principles (GLPs) adopted in 2018, the Loan Syndications and Trading Association (LSTA), the Loan Market Association (LMA) and the Asia Pacific Loan Market Association (APLMA) have recently published a set of voluntary global guidelines entitled the Sustainability Linked Loan Principles (SLLPs).
The demand for loan products that incentivize improvements in borrowers’ sustainability profiles has been rapidly growing and the release of the SLLPs comes at a time when major players are seeking ways to move the market toward more sustainable solutions. Investors are becoming increasingly concerned with how their investment decisions impact the environment and local communities, plus sustainability is now at the core of lenders’ strategic priorities for allocation of resources.
Like the GLPs and the Green Bond Principles before them, the SLLPs aim to promote consistency for market participants in the green and sustainable financing market. In tying loan terms, such as pricing, to a borrower’s sustainability performance targets, SLLPs have the potential to make a concrete impact across several industries.
WHAT ARE SUSTAINABILITY LINKED LOANS?
The SLLPs define sustainability linked loans as “any types of loan instruments and/or contingent facilities (such as bonding lines, guarantee lines or letters of credit) which incentivize the borrower’s achievement of ambitious, predetermined sustainability performance objectives”. In contrast to the GLPs, which focus on the use of proceeds in categorizing a loan as “green”, sustainability linked loans can be used for general corporate purposes and measure the borrower’s performance against sustainability performance targets (SPTs), often by using independent third-party ratings.
The SLLPs also target a wider array of market behaviours than the GLPs. For example, some common categories of SPTs include energy efficiency, greenhouse gas emissions, affordable housing, water consumption and global environmental, social and governance assessments and ratings.
WHAT MAKES A LOAN SUSTAINABILITY LINKED?
As noted above, the use of proceeds is not a determining factor when categorizing a loan as sustainability linked. In fact, in most cases, the proceeds of the loan will be used for general corporate purposes and not for a specified “green” project. Sustainability linked loans operate at the organizational level, aiming to improve the borrower’s overall sustainability profile by tying up loan terms, most typically the pricing, to the borrower’s performance against SPTs. The SLLPs set out a framework for understanding the characteristics of sustainability linked loans, based around four core components:
- Relationship to Borrower’s Overall Social Responsibility Strategy
Sustainability linked loan borrowers should clearly communicate to lenders their sustainability objectives as set out in its corporate social responsibility strategy, and are encouraged to align the proposed loan’s SPTs with their overarching sustainability strategy and objectives. Borrowers are also encouraged to disclose any sustainability standards or certifications to which they aim to conform.
- Target Setting – Measuring the Sustainability of the Borrower
SPTs should be negotiated between borrowers and lenders for each transaction. A sustainability coordinator or sustainability structuring agent may assist borrowers in arranging a sustainability linked loan and negotiating the relevant SPTs.
SPTs are tied to an improvement in sustainability as measured against a predetermined performance target benchmark. SPTs should be ambitious and meaningful to the borrower’s business, which is why market participants recognize that these targets ought to be based on recent performance levels (generally data from the previous six to 12 months).
The SPTs typically take the form of metrics and can include specific targets for a borrower and its subsidiaries such as a carbon dioxide reduction or an increase in the use of electric vehicle fleets. Pricing of a loan can be linked to the borrower’s sustainability performance and for instance, the margin under a sustainability linked loan may increase or decrease depending on whether the borrower meets a specific SPT threshold.
Transparency is considered key to this market. Borrowers should maintain easily accessible performance data with respect to their SPTs and the SLLPs recommend that borrowers provide this information to their lenders at least annually. Where appropriate, borrowers should also be encouraged to publicly report their SPT performance information, whether in their corporate social responsibility report or otherwise.
- Independent Review
The need for external review varies depending on the circumstances and should therefore be negotiated on a transaction-by-transaction basis. Where SPT performance data is not reported publicly or otherwise accompanied by an audit statement, the SLLPs strongly recommend that a borrower seek independent review of their sustainability performance at least annually.
SLLPs IN CANADA AND TRENDS
The SLLPs are just the latest development in the rapid growth of loan products that respond to demands for more sustainable financing. While we have yet to see any significant activity of sustainability linked loans in Canada, the LSTA’s involvement in this initiative means that the SLLPs may soon make their influence felt across the country. Conceived as a broad and flexible framework, the SLLPs are also likely to evolve rapidly as market participants gain experience with sustainability linked loans.
We will continue to keep you updated on the development of these principles and their impact on both the international and domestic lending markets.
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