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The A-Z of secured lending
You would have to be living under a rock not to recognise that environmental issues have become much more of a focus in recent years as ‘going green’ has become a greater priority for everyone, both at an individual level (think tote bags, keep cups and paper straws) and at a corporate level too, as many sectors and organisations make environmental, social and governance (or, “ESG”) criteria, a higher priority.
The lending market has been no exception to this and in December 2018, the Loan Market Association (the “LMA”), together with the Asia Pacific Loan Market Association (“APLMA”) and the Loan Syndication and Trading Association (“LSTA”)) launched its guidance on ‘Green Loan’ principles. In March 2019, the LMA (together with ALPMA and LSTA) also published its ‘Sustainability Linked Loan’ principles.
This blog provides a broad overview of the differences between Green Loans and Sustainability Linked Loans, and considers the extent to which green lending may contribute to a greener planet for everyone (if at all).
The key defining feature of a Green Loan is how the proceeds of the loan are to be used by the borrower. To qualify as a Green Loan, the proceeds must be used in whole or in part for ‘Green Projects’ which provide a clear environmental benefit.
The guidance as to what constitutes a ‘Green Project’ is fairly broad, with the Green Loan principles providing wide reaching categories for eligibility purposes including projects relating to renewable energy, energy efficiency, clean transportation, sustainable water, wastewater management, eco-efficient products and green buildings.
The way in which the proceeds of the loan are used is key to a Green Loan, but the Green Loan borrower should also provide appropriate information to the relevant finance parties in respect of its process, project evaluation and ultimate selection of its green projects. This may include providing details of its environmental sustainability objectives more generally, and the process by which it has considered that its projects fit within the Green Projects eligibility criteria.
The borrower should also manage the proceeds of the Green Loan appropriately by crediting the same into a dedicated Green Loan account and properly tracking how the proceeds are used. If the Green Loan will only comprise one tranche of a loan, then the green tranche must be clearly designated as such, and deposited into a separate account.
Finally, the Green Loan borrower should maintain appropriate records to identify and monitor how the Green Loan (or green tranche) has been used and the expected environmental impact. Such information should then be included in the borrower’s regular reporting.
In some circumstances, it may be appropriate for a Green Loan to be reviewed and rated externally by qualified third parties such as an independent ESG rating provider.
Sustainability Linked Loans are different to Green Loans. The key feature of a Sustainability Linked Loan is that the borrower is incentivised to meet certain pre-determined sustainability performance targets (“SPTs”), rather than being obligated to use the proceeds of the loan in a specific way. Unlike a Green Loan, the purpose of a Sustainability Linked Loan may simply be for general corporate purposes.
Examples of SPTs categories are set out in the Sustainability Linked Loan principles and include improvements in the energy efficiency of buildings or machinery, reductions in greenhouse gasses, increasing the number of affordable housing units, improving its own ESG rating and the achievement of a recognised ESG certification.
Sustainability Linked Loans will often incentivise the borrower by linking the attainment of the agreed SPTs (which the Sustainability Linked Loan principles say should be “ambitious and meaningful to the borrower’s business”), to the terms of the loan. For example, the lender(s) may be entitled to increase or reduce the interest rate margin during the term of the loan, depending on whether the pre-agreed SPTs have been met. The intention is to encourage the borrower to engage in ambitious and positive change itself, thereby contributing to environmentally and socially sustainable economic activity and growth, more widely.
Similarly to the position in relation to Green Loans, a Sustainability Linked Loan borrower should expect to provide detailed information relating to their SPTs, and report on the same at least annually to the relevant finance parties. As with a Green Loan borrower, they may also be reviewed and rated by a third party ESG rating provider.
The LMA is reporting continued growth in the green and sustainability linked loan market, which reported a volume of $99bn in 2018. This aligns with the clear social and cultural shift towards greater engagement with environmental and sustainability issues in recent years, together with the introduction of number of climate change and corporate governance initiatives on national and international levels.
The introduction of the Green Loan principles and Sustainability Linked Loan principles have helped provide this expanding market with a framework of standard guidelines which should help provide some consistency as the market continues to grow and keep any ‘green washing’ criticism, at bay (‘green washing’ is a term used to describe the process of simply utilising clever marketing and PR tactics to give the impression of an (unsubstantiated) environmentally or sustainability based approach to business activities).
The green lending market is still its relative infancy (by way of comparison, the first set of Green Bond principles were launched in January 2014) and so it is difficult to comment on whether the recent expansion in the Green Loans and Sustainability Linked Loans market will genuinely encourage more environmentally and socially sustainable economic activity.
Some may argue that, on the basis the loan market itself is setting its own guidelines and principles as to what constitutes sustainable activity, this could lead to softer ‘Green Projects’ criteria and SPTs than are really required to see any tangible change. There is also an argument that the concept of Sustainability Linked Loans may not go far enough on the basis that they only require the borrower to make improvements to its sustainable activity but could still be made available to organisations operating in an environmentally damaging sector. However, the fact that steps are now being taken to properly address sustainability and environmental issues within the loan market, is surely a step in the right direction.
Anna Shonfeld is an Associate in the Corporate and Commercial department. Anna has experience acting on a range of corporate matters including share sale and purchase transactions, advising on shareholders’ agreements and general commercial contract drafting.
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