Sustainability linked loans (SLLs) aim to facilitate and support environmentally and socially sustainable economic activity and growth. The LMA has published the Sustainability Linked Loan Principles (SLLP) to promote the development of sustainability linked loan products by providing a framework for application by lenders and borrowers.
SLLs are any types of loan instruments and/or contingent facilities (such as bonding lines, guarantee lines or letters of credit) which incentivise the borrower’s achievement of ambitious, predetermined sustainability performance objectives.
The SLLP can be differentiated from the LMA Green Loan Principles as the SLLP focus on the on-going sustainability profile of a borrower over time rather than the delivery (and maintenance) of a specific green project. It is for the borrower to set sustainability performance targets (SPTs) (which are agreed with the lender) by reference to key performance indicators, external ratings and/or equivalent metrics by which the borrower’s sustainability profile can be tracked for the purpose of the loan.
The use of proceeds in relation to a SLL is not a determinant in its categorisation and, in most instances, SLLs will be used for general corporate purposes. Instead of determining specific uses of proceeds, SLLs look to improve the borrower’s sustainability profile by aligning loan terms to the borrower’s performance against the relevant predetermined SPTs.
Examples of sustainability performance targets (SPTs)
Improvements in the energy efficiency rating of buildings and/or machinery owned or leased by the borrower
Greenhouse gas emissions
Reductions in greenhouse gas emissions in relation to products manufactured or sold by the borrower or to the production or manufacturing cycle
Increases in the amount of renewable energy generated or used by the borrower
Water savings made by the borrower
Increases in the number of affordable housing units developed by the borrower
Increases in the use of verified sustainable raw
Increases in recycling rates or use of recycled raw materials/supplies
Sustainable farming and food
Improvements in sourcing/producing sustainable products and/or quality products (using appropriate labels or certifications).
Improvements in conservation and protection of biodiversity
Global ESG assessment
Improvements in the borrower’s ESG rating and/or achievement of a recognised ESG certification
Four key elements which should feature in a SLL
1. Relationship to borrower’s overall CSR strategy
The borrower should clearly communicate to its lenders its sustainability objectives, as set out in its CSR strategy, and how these align with its proposed SPTs.
2. Target setting – measuring the sustainability of the borrower
Appropriate SPTs should be negotiated and set between the borrower and lender group for each transaction with the assistance of, if elected, one or more “Sustainability Coordinator(s)” or “Sustainability Structuring Agent(s)”.
The SPTs should be ambitious and meaningful to the borrower’s business and should be tied to a sustainability improvement in relation to a predetermined performance target benchmark. Market participants recognise that any targets should be based on recent performance levels (often data from the previous 6-12 months). SPTs may be either internal (defined by the borrower in line with their CSR strategy) or external (assessed by independent providers against external rating criteria).
SLLs look to improve the borrower’s sustainability profile. They do so by aligning loan terms to the borrower’s performance against pre-determined SPT benchmarks. For example, the margin under the relevant loan agreement may be reduced where the borrower satisfies a pre-determined SPT threshold or vice versa. By linking the loan terms to the borrower’s sustainability performance, borrowers are incentivised to make improvements to their sustainability profile over the term of the loan.
Borrowers should, where possible, make and keep readily available up to date information relating to their SPTs, with such information to be provided to those institutions participating in the loan at least once per annum.
As transparency is of particular value in this market, borrowers should be encouraged to publicly report information relating to their SPTs and this information will often be included in a borrower’s annual report or its sustainability report. However, this will not always be the case and, where appropriate, a borrower may choose to share this information privately with the lenders rather than making this publicly available.
Eternal reviews of the borrower’s sustainability performance are likely to be periodically required where the borrower does not have the necessary internal expertise to do so. External reviewers may be auditors, sustainability consultants or rating agencies.
How CMS can assist
The likely advantage for both borrowers and lenders is the positive public profile associated with SLLs. For borrowers the potential to attract sustainability-oriented funding and SPT-linked margin ratchets may be another positive of SLLs.
With the link between economic growth, financial stability and the need for sustainability becoming ever more apparent, we expect SLLs to continue expanding and to become more common.
At CMS we are committed to support clients implementing sustainable business practice and have extensive experience in assisting borrowers and lenders in documenting and advising on SSLs.