Sustainability Linked Loan Principles

In March 2019 the Loan Market Association (LMA), the Asia Pacific Loan Market Association (APLMA) and the Loan Syndications and Trading Association (LSTA) launched the Sustainability Linked Loan Principles (SLLPs).

03 May 2019

Author: Fearghal McVey
Practice Area: Banking & Finance

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Summary

In March 2019 the Loan Market Association (LMA), the Asia Pacific Loan Market Association (APLMA) and the Loan Syndications and Trading Association (LSTA) launched the Sustainability Linked Loan Principles (SLLPs).

The SLLPs offer a critical new standard in loan financing, linking a borrower’s sustainability profile to the terms of loans on offer.The SLLPs were developed by a panel of experts comprising representatives from leading financial institutions and represent the latest step in the paradigm shift towards sustainable development.

The SLLPs present an opportunity for borrowers with the requisite sustainability profile to negotiate more favourable terms with their lenders in connection with interest rates and margins on loans, provided a particular level of sustainability can be achieved against set targets and goals.

In addition, the SLLPs present an opportunity to lenders to demonstrate their commitment to sustainable development by effectively rewarding borrowers who achieve a certain standard on sustainability targets with better borrowing terms on relevant loans.

The intention is for broad use by loan market participants and rather than setting out a robust set of rules, they take the form of voluntary guidelines.The SLLPs follow on the heels of the Green Loan Principles (GLPs) which were first published in March 2018, further information on the GLPs can be found here.

Guidance under the SLLPs

The SLLPs have the stated aim to “facilitate and support environmentally and socially responsible economic activity and growth” by providing guidelines on the “fundamental characteristics” of sustainability linked loans.

Broadly a sustainability linked loan is any type of loan which encourages a borrower to achieve certain predetermined sustainability performance objectives.The terms of the sustainability linked loan are thus aligned to certain sustainability performance targets set for the borrower, accordingly the margin applicable to the loan (and thereby the interest payable in connection with the loan) may be adjusted during the life of the loan, provided the borrower achieves the relevant sustainability performance targets (known as SPTs).Examples of SPTs include:

  1. improvements in energy efficiency ratings of buildings which are owned or leased by a borrower;
  2. reductions in greenhouse gas emissions in relation to products manufactured or sold by a borrower;
  3. water consumption savings;
  4. increased use or generation of renewable energy;
  5. increased recycling rates;
  6. increased use of verified sustainable raw materials or suppliers.

Components of the SLLP Framework

The SLLP framework is based on four core components:

  1. relationship to a relevant borrower’s overall CSR strategy;
  2. target setting and measuring a relevant borrower’s sustainability;
  3. reporting by the borrower of its progress against the set SPTs;
  4. review of the borrower’s progress against set SPTs.

1. Relationship

For a sustainability linked loan, the borrower must explain to the lender:

a) its sustainability objectives and wider CSR strategy;

b) demonstrate how (a) aligns with the set SPTs of the borrower;

c) the sustainability standards to which the borrower aims to conform.

2. Target Setting

This is in essence a three-stage process:

a) The lender and borrower agree the SPTs, which should be relevant to a borrower’s business.

b) These SPTs should then be benchmarked appropriately.

c) The loan terms will then be aligned to the borrower’s performance against its set benchmark.As a condition precedent to the loan a third party opinion may be obtained by a borrower as to the appropriateness of their SPTs.A key aim of sustainability linked loans is to encourage positive change through incentives therefore meaningful target setting is crucial to achieving that change. Examples of SPTs are given above.

3. Reporting

Borrowers should report information in connection with their SPTs to lenders at least annually and keep SPT information readily available and up-to-date.

Borrowers are also encouraged (although not compelled) to offer transparency on SPTs by publicly reporting information in relation to their SPTs, for example through annual reports or CSR reporting. The SLLPs do accept that this may not be possible in all cases and in some cases borrowers will only share SPT information privately with lenders.

4. Review

External review (if any) is a point for negotiation between the relevant borrower and lender.A borrower may have its performance against its SPTs independently verified by a qualified external reviewer, such as an auditor, environmental consultant or independent ratings agency.

Where no external review is sought, a borrower should develop internal expertise to validate the calculation of its performance against SPTs.

Once reporting has been completed and following any external review, the lenders will evaluate the borrower’s performance against the SPTs and any corresponding impact of the borrower’s performance against the SPTs will be reflected pursuant to the loan terms (for example improved interest rates or margins being applied).

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