On 23 February 2023 the Loan Market Association (the “LMA”), a leader in developing best practice and producing standard documentation that is widely used across the syndicated loan market in Europe, the Middle East and Africa, published new voluntary principles and guidance for the structuring and labelling of sustainability-linked loans (“SLLs”) and green and social loans (“GSLs”). Unsurprisingly the revised principles and guidance are not a substantial departure from the previous versions produced by the LMA, but, particularly in the guidance notes, they do provide more clarity and practical detail for borrowers and lenders on how to structure loan products that comply with the LMA's SLL and GSL principles.
Borrowers’ ESG credentials are now routinely discussed in the context of new financings and refinancings and the updated LMA guidance and principles are to be welcomed, although these will continue to be products that evolve in line with loan market developments and in tandem with ESG practices and standards adopted in the bond market. The next step in the development of the SLL and GSL principles is set to be the adoption of market standard clauses and we note that the LMA is currently working on an SLL rider that it plans to publish in the coming months.
In terms of timing, it should be noted that the new SLL and GSL principles apply to loans originated, extended or refinanced after 9 March 2023 and any loans financed prior to this date should be reviewed in conjunction with the relevant SLL or GSL principles in force at the time such loans were originated, extended or refinanced.
Sustainability-linked loans are types of loan instruments and/or contingent facilities for which the economic characteristics can vary depending on whether the borrower achieves ambitious, material and quantifiable predetermined sustainability performance objectives. Borrowers select certain key performance indictors (“KPIs”) against which a set of sustainability performance targets (“SPTs”) may be measured and economic variance will typically take the form of a margin ratchet. Borrowers must report on their performance against the relevant SPTs and obtain independent verification of that performance with the results (where possible) made public.
What’s new in the 2023 sustainability-linked loans principles?
As noted above, the new SLL principles and guidance build upon and clarify the previous principles and guidance rather than substantively rewrite them, however, some of the key points to highlight in the new SLL principles and guidance include:
- A renewed focus on KPIs being at the core of a borrower’s business and addressing the most important ESG challenges of a borrower and its industry. Accordingly, the previous general list of example KPIs in the guidance appendix has been deleted and references to baselines and what KPIs are being benchmarked against added to the example of clearly defined KPIs.
- A recommendation that annual SPTs should be set for each KPI for each year of the loan term and (subject to competition and confidentiality considerations) strategic information highlighted that may decisively impact the achievement of the SPTs.
- SPTs may be based on targets that a borrower has already publicly announced; however, the SLL guidance emphasises that SPTs should not be set lower than historical performance and a borrower’s ESG trajectory should show improvement beyond ‘business as usual’.
- Recognition that the ambition of SPTs may vary across geographies and provision (in exceptional circumstances) for SPTs to be agreed within 12 months of origination provided that the loan is not referred to as an SLL until the SPTs are set and the applicable SLL mechanics in the loan documentation are ‘switched on’.
- More detail as to what should be described in verification reports and clarification that KPIs should be verified for any date/period relevant for assessing SPT performance as well as on an annual basis.
Green and social loans
Green loans and social loans are types of loan instruments and/or contingent facilities made available exclusively to finance, refinance or guarantee, in whole or in part, new and/or existing green or social projects with environmentally sustainable or social objectives. GSLs must be aligned to four core components, namely that the use of proceeds must be linked to a green or social asset or project, there must be a clear process for project evaluation and selection, loan proceeds should be credited to a dedicated account or otherwise appropriately tracked by the borrower and borrowers should provide detailed reporting, including annual reports, on the list of green and social projects to which funds have been allocated.
What’s new in the 2023 green and social loans principles?
As with the SLL principles, the GSL principles are an evolution of the previous principles rather than a wholesale redraft. Some of the key points to note in the revised GSL principles and accompanying guidance include:
- Clarification that green and social loans can be used for refinancings, provided that the underlying assets or projects being refinanced are still in use, follow the relevant eligibility criteria at the time of the refinancing and are still assessed as making a meaningful impact. More detail is also provided around GSL refinancings prior to the repayment of existing loans, multiple consecutive GSL refinancing and pledging assets financed by GSLs as collateral.
- GSLs may be used to finance intangible assets and expenditures (such as training, monitoring, research and development) and not all green loans must be climate related.
- A focus on temporarily unallocated GSL proceeds and a requirement that borrowers should disclose how such unallocated GSL proceeds are being placed and seek to ensure that any temporary placements do not damage the integrity of the green loan market (borrowers should also consider ESG placements for such funds).
- Any borrower may be eligible for a GSL, including borrowers whose business activities are purely focused on the green economy (“pure play” borrowers), although where controversial issues are present lenders may require additional disclosure from a borrower.
- Green technologies (such as carbon extraction technologies and energy storage systems) have been added to the non-exhaustive list of eligible green project categories, although it should be noted that carbon offsetting is still not envisaged within the list of eligible green projects.
- Where loans have both social and environmental benefits, the borrower should determine the designation of the loan as either a green loan or a social loan based on the primacy of the intended objectives of the underlying project. Borrowers may also enter into ‘theme’ loans focusing on a particular GSL category out of a more general ESG framework established by a borrower.
- Borrowers should continue reporting on the achieved and estimated impact of GSLs throughout the life of the loan, including information on the prorated impact of GSLs where a borrower has only provided partial financing for a project with a GSL.
- It is now recommended that borrowers appoint an external review provider pre-origination to assess their GSL programme and an external auditor post-origination to verify internal tracking and allocation of funds, although the guidance does provide that in some circumstances self-certification by a borrower may be sufficient.
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