This guide and checklist can be used to introduce borrowers to, and encourage them to access, Sustainability-Linked Loans (SLLs).Skip to clause
Why use this?
Current ESG regulations do not directly impact corporate borrowers outside of the FTSE 100 (in particular leveraged entities), and thus there is no immediate push factor for such borrowers to adopt ESG strategies, including those targeting climate-related outcomes.
However, the expanding regulatory landscape means such companies can expect to be subject to ESG regulations in the near future. In any case, the ability to demonstrate that it has appropriate ESG strategies is also increasingly important to a company’s reputation.
For these reasons, such companies should be incentivised to put in place or improve their ESG (including climate impact mitigation) strategies now. An SLL is one such means.
Unlike Green or Sustainable Loans that require proceeds to be allocated to finance or re-finance “eligible projects”, SLLs are a form of sustainable-financing which can be accessed by companies who are not seeking to finance a specific green project or who do not sit within a ‘green’ industry but who do otherwise have a defined, integrated ESG strategy with clear, measurable targets within their business.
SLLs provide a pull factor to corporate borrowers, by giving them access to a broader pool of investors and an opportunity to reduce their financing costs.
How it promotes a net zero future
Increased awareness of how corporate borrowers can access SLLs (including by inserting sustainability-linked provisions in their existing loan agreements) and their benefits, leading to increased adoption of sustainability measures and incremental and accretive positive climate-related outcomes amongst corporate borrowers.
With access to appropriate financing tools, corporates can act as a driving force in driving down global warming and reducing carbon emissions through private sector action.
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[User note: Clara’s Guide and Checklist should be read in conjunction with Casper’s Clause.]
What are Sustainability-Linked Loans?
- Traditional Green/Sustainable Loans are proceeds-based: the proceeds must be used to finance or refinance eligible projects, whereas Sustainability-Linked Loans are not proceeds-based: proceeds may be used for general corporate purposes.
- Sustainability-linked loans are similar to other corporate borrowing facilities, with the difference typically being that financial / structural changes to the loan may arise from the meeting of (or failure to meet) certain selected and pre-agreed Sustainability Performance Targets (SPTs).
- The SPTs are measured by reference to one or more selected Key Performance Indicators (KPIs). The borrower gains the financial / structural change benefit for meeting the SPTs. In some cases, failure to meet a minimum SPT level may lead to negative financial / structural change for the borrower. The positive and/or negative financial / structural change will be negotiated and determined on a case-by-case basis between corporate borrowers and lenders.
- The most common financial/structural change currently in the market is the interest rate paid by the borrower. Typically, the interest rate will decrease if the borrower meets the SPT(s). In some cases, failure to meet a certain level of the relevant SPT(s) leads to an increase in interest rate.
What might an example of a SLL look like?
The Borrower (B) wishes to enter into a 5-year €1 billion revolving credit facility (RCF) for general corporate purposes. It pays interest of LIBOR + Margin. Without taking into account SPTs, a margin ratchet applies based on its credit rating as follows:
B also agrees for this RCF to be a Sustainability-Linked Loan. It has agreed the following SPTs:
B will provide Sustainability Compliance Certificates at the same time as it supplies Group audited financial statements and other compliance certificates to the lenders. The Sustainability Compliance Certificate will state the number of SPTs met and, based on that, the impact on the Margin:
For example, in April 2022, B has a credit rating of Baa3/BBB-, and thus the applicable Margin would be 1.15%. It provides its audited financial statements for the year ending 2021. Alongside that, it provides a Sustainability Compliance Certificate certifying that, in 2021, it reduced CO2 emissions by 4.20% and Water consumption by 0.32% (in each case compared to the Baseline). B has therefore met both the SPTs. Therefore, the applicable Margin will be reduced by 0.125%, i.e. the Margin B will pay for the applicable interest period will be 1.025%.
Note: The example is illustrative only. SLLs do not have to take the form of new money financings. SLL provisions can also be included during the course of any amendment or refinancing of an existing loan facility.
LMA Sustainability-Linked Loan Principles
Whilst there are no mandatory frameworks for determining what an SLL is, the European market has coalesced around the LMA Sustainability-Linked Loan Principles.
What is a Sustainability-Linked Loan?
- Any type of loan instrument or contingent facility which incentivises the borrower’s achievement of ambitious, pre-determined sustainability performance objectives.
What are sustainability performance objectives?
- Sustainability performance is measured using Sustainability Performance Targets (SPTs), set against Key Performance Indicators (KPIs) which measures improvements in the borrower’s sustainability profile.
The Core Components
Core Component #1: Relationship to Overall CSR Strategy
- Mandatory: Overall sustainability objectives and strategy communicated to lenders?
- Encouraged: Do the selected SPTs align with the borrower’s overarching sustainability objectives and strategy, policy and processes?
- Mandatory: The financing terms should align to the sustainability strategy. Incorporate reward for achieving the SPT. Conversely, failure to meet a minimum SPT leads to loss of the incentive.
- Encouraged: Disclose sustainability standards or certifications obtained or to which borrower is seeking to conform.
Core Component #2: Target Setting – Measuring the Sustainability of the Borrower
- Mandatory: Negotiate and set the SPTs with the lender(s). Consider using a Sustainability Coordinator or Sustainability Structuring Agent to assist.
- Mandatory: SPTs can be internally defined by reference to the borrower’s own global sustainability strategy, or externally (e.g. using independent ratings criteria).
- Mandatory: Are the SPTs ambitious and meaningful to the business? Targets should be based on recent (e.g. 6-12 month) performance levels. Mapping of SPTs against materiality assessment of the borrower or industry to be conducted by the borrower.
- Mandatory: SPTs shall not be set lower, or set on a slower trajectory, than those already adopted internally or announced publicly.
- Mandatory: SPTs shall reference a sustainability improvement based on a predetermined benchmark. Consider both importance of the ESG issue on a materiality assessment plus the scope for improvement.
- Mandatory: SPTs to apply over the life of the loan
- Strongly encouraged: Obtain a third party opinion on the SPTs and alignment with relevant frameworks as a condition precedent to SPT appropriateness. Alternatively, demonstrate internal expertise on methodology verification.
Core Component #3: Reporting
- Mandatory: Keep readily available and up-to-date information relating to the SPTs. Ensure internal processes are set up for this purpose.
- Encouraged: External ESG ratings and/or performance reviews by external auditors, if used, should be maintained.
- Mandatory: Provide sustainability/ESG information to lenders at least once per annum. This should include reports on performance against the SPTs and confirmation that there has been no change to the calculation methodology applied.
- Encouraged: Where providing SPT information, details of underlying methodology, baselines and/or assumptions to be included.
- Encouraged: For private companies, consider publicly reporting information on the SPTs, through annual reports or sustainability reports.
Core Component #4: Review
- Where appropriate: Consider having an external review conducted as a condition precedent.
- Strongly encouraged (if information is not publicly reported): Consider having performance against SPTs independently verified by an external reviewer at least once per annum. External reviews, if conducted, should be by a qualified external reviewer (e.g. auditor, environmental consultant, or independent ratings agency).
- Where appropriate: External reviews should be made publicly available.
- Mandatory (if no external review conducted): Demonstrate or develop internal expertise for validation of calculation of performance against SPTs.
No standard wording is available for use in SLL documentation. There are various voluntary templates in the market (e.g. The Chancery Lane Project’s Casper’s Clause) available for use. However, most lenders and private practice law firms active in this space would have their own language for use based on prior transaction experience.
- Drafting guidelines
- Source and baseline of SPTs should be clearly set out. The mechanism for measuring improvement relative to the SPT should be clearly documented.
- Where information is being relied on to measure the SPT, consider whether independent verification will be required.
- The benefits and consequences of failure to meet SPTs should be clearly defined. The most typical benefit is a margin step-down, and the most typical (if any) consequence for failure to meet a minimum standard is a pricing step-up. Typically, there is no Default / Event of Default arising for failure to meet the SPTs.
- Consequences of breaching ancillary provisions (e.g. failure to provide information, inaccurate reporting) should also be clearly set out – unlike failure to meet the SPTs, these could lead to Default / Event of Default.
- For longer-term loans, SPTs may not be able to be accurately set in advance, or external events or circumstances may require amendment to the SPTs. Include provisions that clearly define conditions under which SPT definitions or calibrations can be updated to ensure sustained alignment with business and sustainability commitments.
What would an example of an SPT look like?
Sustainability is generally synonymous with ESG, which stands for “Environmental, Social and Governance”. There is no definitive list of sustainability / ESG issues, but the table below provides examples of ESG improvements against which SPT parameters can be defined for guidance purposes.
|Energy Efficiency||Improvements in the energy efficiency rating of buildings and/or machinery owned or leased by the borrower.|
|Greenhouse Gas Emissions||Reductions in greenhouse gas emissions in relation to products manufactured or sold by the borrower or to the production or manufacturing cycle.|
|Renewable Energy||Increases in the amount of renewable energy generated or used by the borrower.|
|Water Consumption||Water savings made by the borrower.|
|Affordable Housing||Increases in the number of affordable housing units developed by the borrower.|
|Sustainable Sourcing||Increases in the use of verified sustainable raw materials/supplies.|
|Sustainable Farming and Food||Improvements in sourcing/producing sustainable products and/or quality products (using appropriate labels or certifications).|
|Biodiversity||Improvements in conservation and protection of biodiversity.|
|Global ESG Assessment||Improvements in the borrower’s ESG rating and/or achievement of a recognised ESG certification.|
Source: Sustainability Linked Loan Principles (May 2020), published by the LMA, APLMA and LSTA