What borrowers and lenders need to know as sustainability-linked loans become more popular
The SLL is designed to improve the sustainability profile of the borrower over the life of the loan. For borrowers, SLL is not price driven, as for them the benefit is a better ESG profile by responding to SPTs and benchmarking its success in terms of reputation and credibility rather than chasing pricing. cheaper margin.
Any type of loan financing can be used as SLL. Unlike green or social loans that earmark funds for specific sustainability projects, businesses have the option of applying a general-purpose SLL. Sustainability-linked loans are, as stated, any type of loan instruments or conditional facilities, such as lines of guarantee, lines of guarantee or letters of credit, which incentivize the borrower to achieve ambitious goals. and pre-determined sustainability performance ratings.
Non-compliance with SPTs and KPIs generally does not constitute an event of default. The Principles of sustainability-related lending (SLLP) developed by the Asia Pacific Loan Market Association, the Loan Market Association and the Loan Syndications and Trading Association states that “there is currently no established market standard as to what will constitute a violation of the” sustainability” and this should be clearly documented in the facility agreement for each transaction”. The SLLP provides a general high-level framework to provide guidance on market expectations when issuing SLLs. They contain 5 components of basis of SLLs that are necessary for the integrity of the SLL market: selection of KPIs, calibration of SPTs, loan characteristics, reporting and verification.
Key performance indicators
KPIs must be ambitious and material. Given the intention of the SLL to encourage improvements in corporate sustainability, the selection of relevant KPIs and the calibration of ambitious SPTs are crucial for the effectiveness and credibility of the SLL and the need to prevent accusations of greenwashing. The SLLP requires that KPIs be “relevant, essential and material to the borrower’s overall business, and of high strategic importance to the borrower’s current and/or future operations”. For longer-term transactions or transactions subject to extension options, when not all SPTs can be accurately defined at the start of the loan, or when certain KPIs and SPTs may cease to be relevant over time , the parties must document the precise conditions to allow the update. KPI and SPT calibration to maintain alignment with its sustainability commitment throughout the life of the loan.
There is a wide range of KPIs. The use of generic and immaterial KPIs should not be tolerated in the SLL market and the choice of KPIs must be made on a transaction-by-transaction basis. KPIs and SPTs should be tailored to the particular borrower. A case-by-case approach is fundamental to the integrity of the SLL product. However, the following KPIs are frequently used in SLLs:
- reduction of CO2 or greenhouse gas emissions
- increased use of renewable energy
- diversity goals
- reduction of work accidents
Sustainable development coordinator and ESG consultant
One or more sustainability coordinators are often appointed to help, among other things, negotiate KPIs between the lending group and the borrower. The sustainability coordinator can help identify the most relevant core and material KPIs for that specific industry sector and associated SPTs and negotiate. He can also liaise with external reviewers regarding the choice of KPIs and the calibration of SPTs.
The sustainability coordinator generally acts on a non-dependency basis. Therefore, it is up to each lender to make their own assessment of relevant KPIs with respect to credit and sustainability requirements. Some banks are keen to take on this role, other banks are more cautious about taking on this role or being involved in the review and validation of ESG data.
The borrower can also appoint an ESG consultant to help it with its sustainability strategy or to identify relevant, essential and material KPIs for its business activities. A second party opinion can offer an objective opinion on the materiality of the selected KPIs.
There are no standardized methods for reporting STPs yet, which means that reporting will likely be decided on a loan-by-loan basis. Borrowers must report on their SPTs at least once a year. They are encouraged to provide details of the methodology and underlying assumptions and to confirm that there have been no changes in the calculation. Public reporting is encouraged.
The SLLP guidance notes mention that “there are several sustainability reporting methodologies in the market today. These include the Global Reporting Initiative’s Sustainability Reporting Standards, which provide widely adopted for sustainability reporting”.
Post-signature verification of KPIs and SPTs
The SLLP stipulates that borrowers must obtain independent and external verification of the level of performance of the borrower against the SPT and for each KPI at least once a year. It is recommended that verification of performance against SPTs be made public, where applicable. Unlike external pre-signing review, such as a second-party review, which is recommended, post-signing verification is a necessary part of the SLLP. It is recommended that verification of performance against SPTs also be made public.