Until June and July 2022, the Loan Market Association (AML) published a series of articles to strengthen the integrity of the sustainability-linked lending product (SLL) solve problems related to the definition of key performance indicators (KPIs) and sustainability performance targets (SPT) as well as focusing on the timing issue in SLL trading. Then, on July 12, 2022, the LMA released an introductory guide to the sustainability coordinator role to increase market understanding of this role and how it fits into the broader lending context. durable.
What is LMA addressing?
The popularity of SLLs continues to grow. According to AFME data, the issuance of sustainability and eco-related loans in the European market increased by 106% year-on-year to €284 billion in 2021, from €138 billion. in 2020. Issuance of sustainability and eco-related loans represented 25.4% of total loan issuance in 2021, compared to 13.9% in 2020.
This popularity and the ease of integrating ESG elements into SLLs has raised concerns about “greenwashing”. The express purpose of the LMA in publishing the articles is to provide guidance on writing SLLs to support the credibility and integrity of the product.
Factors to Consider When Negotiating SLLs
Selection of KPIs
- The LMA’s published Sustainability Lending Principles state that the chosen KPIs should be “relevant, essential and material” to the borrower’s business. Although the KPIs remain tailored to each borrower, it would require strong justification if different KPIs are chosen from those used by other borrowers in the same industry sector.
- A borrower should consider external assistance when choosing their KPIs, by appointing a sustainability coordinator to help with the negotiation, engaging an ESG consultant to help with the overall strategy, or reaching out to opinion providers from second part, what we have generally seen in the bond market. Lenders themselves are responsible for challenging the materiality of KPIs.
- Borrowers should consider all material KPIs, not just commonly used ones due to data availability. Environmental factors are still more often chosen over other elements of ESG, although we have increasingly seen borrowers consider social and governance factors when selecting KPIs.
- The SPTs defined for each KPI must have “real scope” and be ambitious. They must go above and beyond any regulatory requirement to show that the borrower is extending rather than following their usual course.
- Parties may consider requiring that SPTs never be lower than the borrower’s publicly announced targets, so that they can tighten them if the borrower announces a more ambitious target. Other recalibration mechanisms can also be considered to ensure that SPTs remain relevant and challenging throughout the life of the SLL.
- Some SPTs may not be linear. If a variation in objectives were to maintain genuine demand on the borrower, this should be recognized.
- Borrowers should not be afraid of not complying with the SPTs. This would indicate that the TPS was sufficiently ambitious, and not defined incorrectly. Borrowers should not downgrade and then reclassify loans as SLL to avoid missed SPTs.
- Parties should not underestimate the time it takes for a borrower early in their ESG journey to negotiate their associated KPIs and SPTs. The rigor of challenge and test proposals should not be compromised just to gain SLL status.
As noted above, we have found that borrowers with existing sustainable finance products and those new to such products (usually) appoint a lender group sustainability coordinator to help the borrower and lenders agree on a syndicated SLL and to align with market practices. . Given the inconsistencies in terminology and approaches, the LMA has issued guidance to clarify the role.
A sustainability coordinator will provide assistance in meeting the requirements of an SLL and negotiating KPIs and SPTs. As they are appointed on a non-dependency basis, the parties will always have to make their own individual assessment. We have seen that borrowers can find themselves a valuable conduit with the wider lender group on the sustainability aspects of an SLL, but the parties still need to understand the product requirements themselves.
Given the various regulatory, market and other factors that encourage sustainable financing, the popularity of SLLs is not expected to wane. Additional guidance and information for borrowers entering this market or expanding their existing sustainable products will help them achieve credible SLLs and maintain product integrity despite new market entrants.
As most borrowers seek to align their KPIs across all of their products, developments in ESG-related obligations should also be monitored. For example, there have been recent guidelines from the International Capital Markets Association (ICMA) (please see ESG Bonds – recent publications from ICMA and FCA, Reena Parmar, Peter Allen, Duncan Kellaway (freshfields.com)) and ICMA has published an update registration approximately 300 key performance indicators for sustainability bonds, which may also be of interest to SLL borrowers.
We are working on a number of SLLs and other sustainable finance products for clients across the debt spectrum and would be happy to advise you on the latest developments.