Sustainable Finance: updated principles and guidance for the lending market

On 23 February 2023, the Loan Market Association (LMA), Loan Syndications & Trading Association (LSTA) and Asia Pacific Loan Market Association (APLMA) updated their high-level frameworks of recommended market standards for sustainable finance (the “2023 Guidance”). 

The 2023 Guidance comprises recommended principles – rather than mandated drafting - to be applied on a deal-by-deal basis. It seeks to both promote consistency, transparency and disclosure across the sustainable loan markets and provide clarity on how to apply the principles contained therein to various transactions. 

The 2023 Guidance constitutes revised versions of the existing principles and guidance in relation to green loans, social loans and sustainability-linked loans (“SLLs”), including both new requirements and recommendations and amendments to the existing frameworks. 

The Green Loan Principles (“GLP”) – part of the 2023 Guidance - are made up of four components:

1. Use of proceeds – proceeds to be used for “green projects” and appropriately described in the finance documents 
2. Process for Project Evaluation and Selection – communication of environmental sustainability objectives, process of selection of eligible project(s) and any environmental risks
3. Management of Proceeds – funds to be credited to a dedicated account or otherwise tracked by the borrower
4. Reporting – annual reporting, to be updated in the case of any material developments

In the current market, investors are actively seeking investment opportunities with “green” credentials. In order to be “green”, the proceeds of a loan must be used by a borrower to fund “green projects”.  The GLP provides more detail on eligible green project categories, noting that such projects should provide clear environmental benefits, including, but not limited to, renewable energy, energy efficiency, clean transportation and green buildings. 

Once the borrower has determined that its project is “green”, the borrower will need to consider the appointment of an external reviewer to assess whether the proposed loan aligns with the GLP’s components. The GLP specifies that the borrower should have both formal and informal attestation processes linked to the borrower’s lending and investment operations for green processes (to track the allocation of the green loan) and transparent reporting process (to monitor compliance with its funder’s green loan requirements). The GLP also expands upon the requirements for external reviewers. 

The Social Loan Principles (“SLP”) – part of the 2023 Guidance - are made up of the same four components as green loans, save that the proceeds are to be used for “social projects” (e.g. affordable housing and basic infrastructure).

The revisions to the SLPs as part of the 2023 Guidance are similar to the revisions to the GLPs, noting that the borrower attestation requirement in the GLPs was already included in the existing social loan guidance. 

Unlike for green loans and social loans, use of proceeds is not a determinant in categorising a loan as an SLL; instead, there must be an economic impact based on whether a borrower achieves (or not) predetermined key performance indicators (“KPIs”) or sustainability performance targets (“SPTs”).

The Sustainability-Linked Loan Principles (“SLLP”) - part of the 2023 Guidance – are made up of five components:

1. Selection of KPIs – KPIs that are material and core to the business of borrower, considering the economic, social and governance challenges of both the borrower’s business and its industry sector.
2. Calibration of SPTs – ambitious, quantifiable and relevant SPTs that the borrower must achieve in respect of each KPI over the life of the loan. 
3. Loan Characteristics – economic characteristics (e.g. margin adjustment) vary depending on whether the pre-determined SPTs are met.
4. Reporting – annual reporting to allow lender to monitor the performance – and continuing relevance – of SPTs, which shall include a verification report outlining performance against SPTs.
5. Verification – independent and external verification of the borrower’s performance as against each SPFT for each KPI.

The definition of SLL has been amended in the SLLP to focus on the economic impact of material and quantifiable pre-determined SPTs. In the healthcare sector, it has been historically difficult to measure sustainability as KPIs need to be linked to ensuring healthy lives and promoting well-being and this remains a challenge. In the life sciences industry, KPIs will largely focus on the “Social” element, with metrics being based on the trust and quality of biopharma products, the access and affordability of medicines and responsible innovation in relation to the curative therapies and rare diseases that the products are created for. 

The SLLP also include a requirement for borrowers to deliver a “sustainability confirmation statement” which – together with the verification report attached thereto – will outline that borrower’s performance against the SPTs for the relevant year and the resulting impact on the economic elements of the loan. 

If a lender is appointed as a sustainability co-ordinator for a syndicated loan, the SLLP clarifies the scope of their role; however, even if such co-ordinator is appointed, the SLLP confirms that each Lender must satisfy themselves as to the borrower’s ESG credentials, as evidenced by the KPIs and SPTs. 

All loans originated, extended or refinanced after 9 March 2023 must fully align with the relevant 2023 Guidance in order to be classified (as relevant) as “green loans”, “social loans” or “SLLs”. 

While the 2023 Guidance aims to improve consistency, all transactions will be bespoke, depending on the relevant borrower’s business, stakeholders and sector. Due to the number of sub-sectors within the healthcare and life sciences industry, analysis of ESG factors may be further broken down to take account of the variance within the wider sector. 

ESG policies and processes will no doubt remain a key focus for investors, borrower and lenders across the loan market. Market participants should continue to avoid “Greenwashing” by setting KPIs that are material and core to the business of the borrower and SPTs that are sufficiently ambitious and meaningful and capable of accurate and sufficient monitoring.