In another welcome addition to this fast-moving area of finance, the Loan Market Association (LMA), together with the Asia Pacific Loan Market Association (APLMA) and the Loan Syndications and Trading Association (SLTA), has introduced the Sustainability Linked Loan Principles (SLLP). This comes after the introduction of the Green Loan Principles (GLP) in March 2018 (see Stibbe's June 2018 short read).
Green loans are defined in the GLP as "any type of loan instrument made available exclusively to finance or re-finance, in whole or in part, new and/or existing eligible Green Projects." We mentioned in our June 2018 short read that as well as green loans that fall within the scope of the GLP, there are other types of financing also considered to be 'green loans'. It is for these types of loans, termed 'sustainability linked loans', that the SLLP have been developed.
According to the LMA, the sustainability linked loan product is a "dynamic and innovative product that enables lenders to incentivise improvements in the borrower's sustainability profile by aligning loan terms (for example, margins) to the borrower's performance against ambitious, pre-determined sustainability performance targets." Contrary to a green loan under the GLP, sustainability linked loan products can have different (non-green) purposes, for example the financing of general corporate purposes.
The SLLP consist of voluntary recommended guidelines providing a framework for sustainability linked loan products. The principles consist of four core components:
Relationship to Borrower's Overall Corporate Social Responsibility (CSR) Strategy
The borrower should inform its lenders of its sustainability objectives (as set out in its CSR strategy) and how these objectives align with the proposed Sustainability Performance Targets (SPTs, further explained below).
Target Setting – Measuring the Sustainability of the Borrower
The borrower (possibly with the assistance of a 'Sustainability Coordinator' or 'Sustainability Structuring Agent') and its lenders should agree the SPTs applicable to the specific transaction. The SPTs should be "ambitious and meaningful to the borrower's business". The key element of this principle (and the SLLP as a whole) is to incentivise the borrower to improve its sustainability profile over the life of the loan by linking the loan terms to the borrower's performance against the agreed pre-determined benchmarks. If the borrower meets a pre-determined SPT, the loan terms become more favourable, such as a decrease in interest margin.
Transparency and openness are essential components of the sustainable loan market. The borrower should keep up to date information on their SPTs readily available, and provide reports to its lenders at least annually. The SLLP encourage the borrower to make this information publicly available, as well as information on underlying methodology and/or assumptions used.
It is up to the borrower and its lenders to agree on a transaction-by-transaction basis whether an external independent review of the SPTs is required. Factors to consider when making this decision include (for example) (i) whether the borrower is listed, (ii) whether information on the borrower's SPTs is publicly available, and (iii) the presence of in-house expertise. If no external review takes place, the SLLP strongly recommend borrowers to demonstrate or develop internal expertise to validate its performance against the SPTs. For a publically listed borrower, it may be sufficient for lenders to rely on the borrower's ongoing disclosure requirements.
Appendix 1 to the SLLP contains a non-exhaustive, indicative list of common categories of SPTs (such as energy efficiency, renewable energy and water consumption), together with examples of improvements an SPT might aim to measure.
Both lenders and borrowers are increasingly aware of the pressure to consider the impact of their activities on the environment, and as a result parties are looking at ways to incorporate their CSR targets into their financing arrangements. The importance of green and sustainable development has not gone unnoticed by the regulators, with the European Commission recently highlighting once more the need to scale up sustainable finance globally, and announcing further initiatives in this area. There are indications that this may include beneficial capital treatment for sustainable loan products, which may further incentivise lenders to look for opportunities to participate in this growing market. We consider the introduction of the SLLP a significant development in the industry that will contribute to the consistency, integrity and transparency in sustainable finance.
The SLLP can be accessed at https://www.lma.eu.com/application/files/8015/5307/4231/LMA_Sustainability_Linked_Loan_Principles.pdf