New industry guidance clarifies the sustainable loan market

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White & Case LLPThe Loan Market Association ("LMA"), Loan Syndication and Trading Association ("LSTA") and Asia Pacific Loan Market Association ("APLMA") have published new guidance1on the key aspects of the Green Loan Principles ("GLP")2and the Sustainability-Linked Loan Principles ("SLLP")3. In this two part series, we discuss the new guidance in relation to the GLP and SLLP here, and in part two we will discuss what financing situations favour which structure.

The launch of the GLP in 2018 and the SLLP in 2019 were key milestones in the sustainable finance market. These voluntary principles have played a part in contributing towards a boom in popularity for the products they codified, and this popularity is only accelerating.

In 2019, over US$163 billion4of green and sustainability-linked loans were extended – an almost 250% increase on what was reported the previous year (see diagram below). In light of how rapidly this market segment is developing, this new guidance on the key aspects of each product is timely as sustainable loans are an essential tool to help businesses to operate on a more sustainable basis.

Green and sustainability-linked loan volumes (US$bn) (Source: Refinitiv; FT)

Green and sustainability-linked loan volumes (PNG)

A recap of green loans and sustainability-linked loans

Green loans ("GLs"), based on the GLPs, are generally structured in the same way as standard loans except that the loan proceeds are tracked and allocated to eligible green projects. The GLPs contain a non-exhaustive list of indicative categories including renewable energy, energy efficiency, clean transportation, pollution prevention and control, sustainable water management and use and green buildings. GLs also require: transparency about how (in the context of the borrower's broader sustainability framework) the projects are selected and how the funds are allocated; and reporting on the environmental impact of the specific project.

Sustainability-linked loans ("SLLs"), based on the SLLPs, deviate from the "use of proceeds" model that was previously the classic model for the sustainable finance market. Unlike GLs, SLLs involve setting "sustainability performance targets" ("SPTs") for the borrower (e.g., if "internal," reduction in greenhouse gas emissions; improvements in energy efficiency; or if "external," attaining a certain sustainability rating from an external reviewer) and if these targets are met, the borrower is rewarded with a ratcheting down of the loan's interest rate (and, on two way pricing structures, penalised by an increase in the interest rate if the targets are not met). SLLs are more flexible (and, in the context of the loan market, more scaleable) as their proceeds do not need to be allocated exclusively (or indeed at all) to green projects. A comparison of the key aspects of GLs against SLLs is set out below:

  Green Loans Sustainability-Linked Loans
What do they entail? Four point criteria applied to loans used exclusively to finance or refinance new and/or existing eligible green projects. Four point criteria applied to loans which actively incentivise the borrower's achievement of pre-agreed SPTs.
Restrictions on use of proceeds? Yes. Proceeds must be used exclusively for green projects, falling under specific categories. Proceeds must be credited to a dedicated account to ensure they remain separate. No. A loan could be a general corporate purposes facility or any other purpose (provided that it doesn't contradict the principle of supporting environmentally and socially sustainable economic activity and growth).
Impact on interest rate? None prescribed/contemplated by the GLP. Yes. The borrower's performance against its SPTs is reflected by reduction or increase in interest rate.
Ongoing Reporting Use of proceeds information to be updated annually until fully drawn and in the event of material developments thereafter. Information relating to SPTs should be provided at least annually. Borrowers encouraged to publicly report information relating to SPTs.
Review External review is recommended "where appropriate" but not required.

External review to be negotiated on case-by-case basis, but encouraged where SPT data is not already the subject of independent assurance.

For listed companies, lenders may rely on public disclosures.

What has the guidance clarified?

The new guidance documents provide concise, practical information on the characteristics of each sustainable loan product, as well as responses to frequently asked questions on how these aspects could be built into the loan documentation. This guidance can assist borrowers and underwriters who are interested in making a first foray into the sustainable loans market, as well as more seasoned market participants to ensure they are incorporating current market best practices into their loan structures.

Key takeaways from the GL guidance include:

  • It is possible for both term loans and revolving credit facilities to be compliant with the GLP and therefore characterised as GLs;
  • Just like green bonds, GLs may be used to refinance existing green projects as well as new ones; we view the refinancing element as particularly relevant for financial institution borrowers as it enables recycling of capital;
  • Loans to fund projects that significantly improve the efficiency of use of fossil fuels are potentially eligible to be classed as a GL, as long as the loan follows the GLP and the borrower is on a transition pathway away from fossil fuel reliance that is aligned with the Paris Agreement;
  • Suggestions on how to avoid questions of 'greenwashing'- primarily through a combination of:
    • scrutiny (both day 1 and ongoing) of the relevant project;
    • consequences of breach of the use of proceeds requirement or other "green" terms;
    • transparency;
  • In what circumstances an external review might be recommended; and
  • Considerations when drafting "green clauses" in loan documentation, including what constitutes a breach of these terms (and the contractual consequences of breach).

Key takeaways from the SLL guidance include:

  • Suggested methodologies for setting ambitious sustainability targets (SPTs) tailored to the borrower's business (taking into account both: (i) the relationship between the SPTs and any materiality assessment within the company's overall sustainability framework; and (ii) the scope for improvement);
  • Suggestions on how to avoid questions of 'greenwashing'- primarily through a combination of:
    • genuinely ambitious target setting (see above);
    • the use of industry initiatives and standards in the qualitative performance indicators for the SPTs;
    • reporting and review where appropriate; and
    • transparency;
  • The nature of the role of a sustainability coordinator or structuring agent for negotiating, testing and validating SPTs (and the need for lenders to satisfy themselves as to the appropriateness of the SPTs and the terms of the SLL more generally); and
  • Best practices in documenting SLLs, in particular: considerations where SPTs are to be revised over the course of a longer-term loan; and what could constitute a breach of the operative provisions of the SLL (and the contractual consequences of breach).

Concluding thoughts

Sustainable loans of both varieties are among the newest and fastest growing asset classes in the sustainable finance market, and the new guidance from the loan market industry bodies provides strong encouragement to potential borrowers and calibration for the rest of the market to ensure best practices are being followed.

In part two of this series, we will compare the GL and SLL structures and their uses in the wider sustainable finance context.

1 The GLP guidance is available here: https://www.lma.eu.com/application/files/7215/8866/8713/GLP_Guidance_V06.pdf The SLLP guidance is available here: https://www.lma.eu.com/application/files/3815/8866/9028/SSLP_Guidance_V04.pdf
2 https://www.lma.eu.com/application/files/1815/8866/8537/Green_Loan_Principles_V03.pdf
3 https://www.lma.eu.com/application/files/5115/8866/8901/Sustainability_Linked_Loan_Principles_V032.pdf
4 According to Refinitiv.

Alexander Buchanan (White & Case, Professional Support Legal Assistant, London) contributed to the development of this publication.

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DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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