The Loan Market Association (“LMA”), the Loan Syndication and Trading Association (“LSTA”) and the Asia Pacific Loan Market Association (“APLMA”) have issued new guidelines1on the key aspects of the Green Loan Principles (“GLP”)2and Sustainability-Related Lending Principles (“SLLP”)3. In this two-part series, here we discuss the new GLP and SLLP guidelines, and in part two, we’ll discuss which funding situations favor 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 contributed to the rise in popularity of the products they codified, and this popularity is only accelerating.
In 2019, over $163 billion4green and sustainability-related loans were granted, an increase of almost 250% compared to the previous year (see diagram below). Given how rapidly this market segment is growing, this new guidance on key aspects of each product is timely, as sustainable lending is an essential tool to help businesses operate on a more sustainable basis.
Green and sustainability lending volumes (in billions of US dollars) (Source: Refinitiv; FT)
A summary of green loans and loans linked to sustainable development
Green Loans (“GL“), based on GLPs, are generally structured in the same way as standard loans, except that the loan proceeds are tracked and allocated to eligible green projects. 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 the environmental impact of the specific project.
Sustainability Linked Lending (“SLL“), based on SLLPs, deviate from the “use of funds” model that was previously the classic sustainable finance market model. Unlike GLs, SLLs are about setting “sustainability performance targets” (“SPT“) for the borrower (e.g., if ‘internal’, reducing greenhouse gas emissions; improving energy efficiency; or if ‘external’, obtaining a certain sustainability rating from an assessor external) and if these targets are met, the borrower is rewarded with a lower interest rate on the loan (and, on two-way pricing structures, penalized with 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 scalable) because their proceeds do not need to be earmarked exclusively (or even at all) for green projects. key aspects of GLs versus SLLs is presented below:
What did the directive clarify?
The new guidance documents provide concise and practical information on the characteristics of each sustainable loan product, as well as answers to frequently asked questions about how these aspects could be incorporated into the loan documentation. These tips can help borrowers and underwriters looking to make a first foray into the sustainable lending market, as well as more experienced market participants to ensure they incorporate current market best practices into their lending structures.What did the directive clarify?
Key takeaways from the GL guidelines include:
- Term loans and revolving credit facilities may be GLP compliant and therefore qualify as GL;
- Just like green bonds, GLs can be used to refinance existing green projects as well as new ones; we consider that the refinancing element is particularly relevant for borrowers of financial institutions because it allows the recycling of capital;
- Loans intended to finance projects that significantly improve the efficiency of fossil fuel use are potentially eligible to be classified as GL, as long as the loan follows the GLP and the borrower is on a transition path away from dependence on fossil fuels which is aligned with the Paris Agreement;
- Suggestions on how to avoid “green bleaching” issues – mainly by combining:
- careful review (day 1 and ongoing) of the project concerned;
- the consequences of failing to comply with the product use requirement or other “green” conditions;
- Under what circumstances can an external review be recommended? and
- Considerations when writing “green covenants” in loan documentation, including what constitutes a breach of these terms (and the contractual consequences of a breach).
Key takeaways from the SLL guidelines include:
- Suggested methodologies for setting ambitious sustainability goals (SPTs) appropriate to the borrower’s business (taking into account both: (i) the relationship between the SPTs and any materiality assessment within the overall sustainability framework business; and (ii) room for improvement);
- Suggestions on how to avoid ‘green bleaching’ issues – mainly by combining:
- setting truly ambitious targets (see above);
- the use of industry initiatives and standards in qualitative TPS performance indicators;
- reporting and review, as required; and
- The nature of the role of a sustainability coordinator or structuring agent in negotiating, testing and validating SPTs (and the need for lenders to ensure the relevance of SPTs and SLL terms more generally) ; and
- Best practices for SLL documentation, in particular: considerations that SPTs should be reviewed during a longer-term loan; and what might constitute a breach of the SLL’s operational provisions (and the contractual consequences of a breach).
Sustainable loans of both varieties are among the newest and fastest growing asset classes in the sustainable finance market, and new guidelines from lending industry bodies strongly encourage potential borrowers and benchmarking for the rest of the market to ensure best practices are in place. monitoring.
In the second part of this series, we will compare GL and SLL structures and their uses in the broader context of sustainable finance.