One continuing trend in the syndicated loan markets is the rise of sustainability-linked loans. These are loans with incentives and/or disincentives (e.g. a higher or lower margin payable as part of interest payments) to a borrower to achieve certain sustainability performance targets (SPTs). Whether targets are met is measured by key performance indicators (KPIs) that relate to the borrower’s business and how it can be made more sustainable.
In practice, a borrower agrees the SPTs and the KPIs for its sustainability-linked loan from lenders with the assistance of a “Sustainability Coordinator” (or “Sustainability Structuring Agent”).
The Sustainability Coordinator’s role and responsibilities
Where a Sustainability Coordinator is appointed in loan documentation, usually being one of the original lenders, its role is to agree with the borrower and the lenders on (i) sustainability targets, (ii) the monitoring of KPIs, and (iii) the reporting on KPIs and on targets being achieved or not. The Sustainability Coordinator is expected to discuss with the Borrower the level of ambition in setting the SPTs and KPIs, the consequences of meeting or not meeting them and the role of the borrower and external sustainability and other advisers or reviewers in relation to monitoring and reporting. In doing so, the Sustainability Coordinator will take into account policies and other standards expected by lenders. However, the Sustainability Coordinator will generally not take responsibility for verifying whether sustainability standards of individual lenders, the syndicate or market standards in sustainability are met.
Once the loan documentation, including KPIs and targets, are agreed, the role of the Sustainability Coordinator is generally completed, as reports on KPIs and targets by the borrower or its external advisers or reviewers are collected by the agent on behalf of all the lenders. If targets are met or not met, the consequential changes in margins are coordinated between the relevant agents and lenders directly. The role of the Sustainability Coordinator may come into play again if KPIs or targets were not yet agreed in detail on the signing of the loan documentation, or if they need to be amended or adjusted during the life of the loan.
The Sustainability Coordinator is appointed by the borrower in the loan documentation, similarly to the appointment of other agents, on the basis of a previously agreed Sustainability Coordinator mandate setting out the responsibilities and fees of the Sustainability Coordinator.
The Sustainability Coordinator has responsibilities towards the borrower and the lenders, which include requesting the borrower to comply with the agreed provisions, if need be, and to report to lenders on the progress (or lack of progress) towards the targets. Typically, the Sustainability Coordinator limits its liability towards the borrower and the lenders in the mandate and loan documentation and usually to the same extent as other agents.
The role and responsibilities of Lenders
In addition to the Sustainability Coordinator, lenders must also ensure that the identification and selection of KPIs and sustainability targets and the monitoring and reporting of requirements imposed on borrowers measure up to legal, regulatory and market standards. During the life of the loan, each lender itself remains responsible for checking compliance with agreed provisions and, in the event of non-compliance, a dialogue between the lenders and the borrower is required, with the Sustainability Coordinator guiding the discussions.
If a borrower fails to meet sustainability targets or monitoring and reporting procedures under sustainability-linked loans, the interest margin of the loan usually increases, but there is generally no draw-stop or event of default. In such cases, a borrower could effectively choose to opt out of sustainability-linked provisions, foregoing an interest margin discount or accepting an interest margin increase in favour of avoiding costs related to sustainability-linked compliance.
Some lenders argue that they should be able to impose draw-stops and declare defaults on loans in such cases, pointing out that non-compliance by borrowers with sustainability-linked provisions could expose the lenders and the Sustainability Coordinator to legal, regulatory, supervisory or reputational risk, including the risk of liability claims and litigation against lenders for “greenwashing” their financial products and services.
However, from a borrower’s perspective it is clearly undesirable that its funding could be jeopardized due to circumstances beyond its control, which could drive borrowers out of the sustainable finance markets altogether. This, in turn, would certainly not help lenders and Sustainability Coordinators to achieve their fair share of global and national sustainability objectives and to fulfil commitments to direct significant funding to ESG- and sustainability-linked loans to borrowers.
If you have any questions about ESG or sustainability in the Financial Markets, please do not hesitate to contact us.