These debt instruments present benefits for companies, investors and lenders, including impact on pricing, relational and reputational benefits and investment in environmental and social change. These instruments, and their benefits, are increasingly available to all sorts of corporate issuers across an expanding universe of industries and may take the form of bonds, term loans, revolving loans and other working capital facilities. This article focuses first on Green Bonds and Green Loans and will then address sustainability-linked instruments.2
Green Bonds And Green Loans
Green Bonds are typically issued to raise funds that are applied to finance “green” projects or issuers with defined environmental benefits, goals or KPIs. While originally formulated as a debt instrument for governments, in November 2013, the first corporate Green Bond was issued by Vasakronan, a Swedish property company, to fund energy efficient new buildings, retrofitting existing buildings as well as renewable energy projects, among other things. Since then, many large corporate issuers have tapped the Green Bond, including Apple, Bank of America, Citigroup, Goldman Sachs, PepsiCo, Visa, Verizon, Volkswagen and Toyota.
Determining whether a bond is “green” depends on the eligibility of the project to which it relates and not the eligibility of an issuer. Even companies in industries that may not be universally considered to be “green,” including those with high greenhouse gas emissions, can tap into the Green Bond market if the project to be financed meets the certain eligibility criteria. The most commonly used standards for Green Bonds are the Green Bond Principles (“GBP”),3 a set of voluntary guidelines set out by the International Capital Market Association (the “ICMA”) and developed through extensive dialogue within a representative group of issuers, investors and intermediaries. The GBP were designed to encourage transparency and disclosure around Green Bond issuances and to increase allocation of capital to eco-friendly projects. Green Bonds can be structured as a typical corporate bond with recourse to the issuer and its group or as project bonds, revenue bonds or asset-backed bonds. The GBP consist of four key components: 1) Use of Proceeds, 2) Process for Project Evaluation and Selection, 3) Management of Proceeds and 4) Reporting.
Use of Proceeds: Use of Proceeds is the key component of the GBP. The “eligible green project” financed or refinanced by an issuance should be clearly identified, and, if possible, quantified, in the “ Use of Proceeds” section of the offering document. The financing will need to be clear and with specific disclosure around the intended uses, including around particular projects, and their continued or expected environmental benefit. Note that it is possible to fund only a portion of the total cost of a project with Green Bonds if other parts of the project would otherwise be ineligible, provided that Green Bonds are only used to fund the eligible portion. A non-exclusive list of eligible green categories that can be selected for the use of proceeds includes:
- renewable energy;
- energy efficiency;
- pollution prevention and control;
- management of living natural resources and land use;
- terrestrial and aquatic biodiversity conservation;
- clean transportation;
- sustainable water and wastewater management;
- climate change adaptation;
- eco-efficient and/or circular economy adapted products;
- green production technologies and processes; and
- green buildings.
Some examples of eligible green projects undertaken by Green Bond issuers include Apple’s transition to 100% recycled aluminum alloy, Bank of America’s investment in numerous solar and wind farms, PepsiCo’s purchase of more sustainable plastics and packaging, Verizon’s conversion to using all light-emitting diodes (LEDs) in its facilities, and Volkswagen’s contributions to e-charging infrastructure.
Process for Project Evaluation and Selection: Companies issuing Green Bonds are expected to provide clear communication to investors about the objectives of any environmentally beneficial projects, the protocols used in determining the project’s adherence to the Green Projects list above and other eligibility criteria.
Management of Proceeds: The GBP encourage issuers to ring-fence the net proceeds of an issuance in an external or internal account and attested to by a formal allocation process. The company will typically need to inform investors about the types of temporary investments any unallocated funds are being held in, and auditors are often tasked with independently evaluating the allocation of funds.
Reporting: Under the GBP, companies are expected to prepare and make readily available annual disclosures on the use of proceeds until the proceeds of the bond sale have been fully allocated. Companies will also report new material developments. The annual report will include a list of the projects to which Green Bond proceeds have been allocated, as well as a brief description of the projects and the amounts allocated, along with their expected impact. Impact reporting should provide quantitative and qualitative information. The GBP also recommend core indicators for two sectors, energy efficiency and renewable energy, and reference reporting templates that issuers could adapt to their own circumstances.
The corollary to Green Bonds in the loan market are Green Loans, which, like Green Bonds, are a use-of-proceeds or project-specific instrument used to finance or refinance an eligible green project. The Green Loan Principles (“GLP”)4 are the voluntary guidelines from the Loan Market Association (the “LMA”), the Asian Pacific Loan Market Association (the “APLMA”), and the Loan Syndications and Trading Association (the “LSTA”) that set out the framework for Green Loans, which is substantially the same as the GBP, subject to differences inherent to the private nature of loans.
As is the case with Green Bonds, identifying a loan as “green” turns on the eligibility of the project to which it relates and not the eligibility of an issuer — projects associated with industries that are traditionally associated with negative environmental impact, such as the production of fossil fuels, can be eligible so long as the core components for eligibility are met (e.g., projects to improve the efficiency of fossil fuel production).
Sustainability-linked debt instruments are not use-of-proceeds or project specific, but look instead to improve a company’s overall ESG performance through sustainable performance targets (“SPTs”) agreed upon by a company and its investors. These instruments can be in loan or bond format, but include one or more SPTs that either reward a company for meeting its SPTs or (more frequently for bonds) penalize a company for falling short (or both) often in the form of a toggle in interest rate margin and fees.
The Sustainability-Linked Loan Principles (“SLLP”)5,6 are a set of voluntary guidelines from the LMA, APLMA and LSTA, which provide four-key components for sustainability-linked instruments: 1) Relationship to Borrower’s Overall Sustainability Strategy, 2) Target Setting, 3) Reporting and 4) Review. Application of these criteria centers around the agreed upon SPTs. SPTs may tie to environmental concerns, ESG scores (more common in European deals), diversity metrics or other ESG concerns and are intended to be complementary or enhancing of a company’s overall ESG strategies.7
Common across the board for the GBP, GLP and the SLLP is the importance of transparency and measurement around the ESG impact of a Green Bond, Green Loan or sustainability-linked debt. All guidance recommends the benefits of external sources and their involvement in nearly all stages of the process. For example, external evaluation of an “eligible green project” or external auditing of compliance with SPTs and second-party opinions and third-party verification are now standard in Green Bond issuances. New services have developed to facilitate the sustainable finance market, providing for certifications and opinions on green credentials, external auditing and ESG scores. These include Sustainalytics, Centre of International Climate and Environmental Research Oslo (CICERO), Vigeo, Leadership in Energy and Environmental Design (LEED) and Climate Bond Initiative.
Although the sustainable finance market is still a relatively small part of the overall debt markets, issuances of Green Bonds, Green Loans and sustainability-linked debt instruments look set to continue their upward trajectory as ESG factors increase in importance for both companies and investors.
1 See Citi, Environmental and Social Policy Framework (July 2020), https://www.citigroup.com/citi/sustainability/data/Environmental-and-Social-Policy-Framework.pdf; GS Social Impact Fund (May 31, 2014), https://www.goldmansachs.com/insights/impact-investing/touts/fact-sheet.pdf; JPMorgan Chase & Co., Sustainability: Our Commitment to Sustainable Development, https://institute.jpmorganchase.com/impact/sustainability.
2 Although this article focuses on the Environmental component of ESG, debt instruments leveraging social and governance criteria also exist in the market. For example, at least two sustainability-linked loans have recently been issued with metrics tied to the number of women involved in management. See Press Release, LANXESS, LANXESS signs “sustainable” revolving credit facility of EUR 1 billion (Dec. 4, 2019), https://lanxess.com/en/Media/Press-Releases/2019/12/LANXESS-signs-%E2%80%9Csustainable%E2%80%9D-revolving-credit-facility-of-EUR-1-billion; and Press Release, SUEZ worldwide, SUEZ announces the successful renegotiation of its main revolving credit facility now indexed to extra-financial performance criteria (Apr. 19, 2019), https://www.suez.com/en/news/press-releases/suez-announces-the-successful-renegotiation-of-its-main-revolving-credit-facility-now-indexed-to-extra-financial-performance-criteria.
3 The Green Bond Principles, promulgated in June 2018, are available at https://www.icmagroup.org/assets/documents/Regulatory/Green-Bonds/Green-Bonds-Principles-June-2018-270520.pdf.
4 The Green Loan Principles, promulgated in May 2020, are available at https://www.lsta.org/content/green-loan-principles/ and the related Guidance on Green Loan Principles, promulgated in May 2020, is available at https://www.lsta.org/content/guidance-on-green-loan-principles-glp/.
5 Sustainability-linked loans are more prevalent than sustainability-linked bonds, with the first sustainability-linked bond being issued in September 2019 by Enel SpA, an Italian power company. See Practical Law Finance, What’s Market: Green and Sustainability-Linked Loans (Jan 7, 2020).
6 The Sustainability-Linked Loan Principles, promulgated in May 2020, are available at https://www.lsta.org/content/sustainability-linked-loan-principles-sllp/ and the related Guidance on Sustainability-Linked Loan Principles, promulgated in May 2020, is available at https://www.lsta.org/content/guidance-on-sustainability-linked-loan-principles-sllp/.
7 Royal Dutch Shell PLC entered into a new revolving credit facility in December 2019, under which its interest rate and fees are linked to meeting targets to reduce its net carbon footprint of energy products that it sells. Press Release, Royal Dutch Shell plc, Shell Signs Innovative $10 Billion Revolving Credit Facility (Dec. 13, 2019), https://www.shell.com/media/news-and-media-releases/2019/shell-signs-innovative-dollar-10-billion-revolving-credit-facility.html.