Green, Social and Sustainability-Linked Loans
Banking & Finance / Bahrain
Faizan ToorAssociate,Banking & Finance
The Asia Pacific Loan Market Association (“APLMA”), Loan Market Association (“LMA”) and Loan Syndications and Trading Association (“LSTA”) have published the green loan principles (the “Green Loan Principles”), the social loan principles (the “Social Loan Principles”) and the sustainability-linked loan principles (the “Sustainability-Linked Loan Principles”) (collectively, the “Principles”). Each set of Principles have been published along with voluntary recommended guidelines to (i) promote the development of each of these products, to underpin and strengthen its integrity; (ii) illustrate the fundamental characteristics of each of the green, social and sustainability-linked loans; (iii) provide market practitioners with clarity on the application of each of the Principles; and (iv) promote a harmonised approach.
In this article, we will provide an overview of the fundamental characteristics of green, social, and sustainability-linked loans and highlight the key differences between them.
The green loan market aims to facilitate and support the key role that credit markets can play in financing progress towards environmental sustainability.
According to the Green Loan Principles, green loans are defined as any type of loan instruments and/or contingent facilities (such as bonding lines, guarantee lines or letters of credit) made available exclusively to finance or re-finance or guarantee, in whole or in part, new and/or existing eligible green projects and which are aligned to the four core components (detailed below) of the Green Loan Principles. While the Green Loan Principles do not entail a fixed definition of what constitutes a green project, the definition of a green project may vary depending on sector and geography.
However, the Green Loan Principles do entail a non-exhaustive list of indicative categories of eligibility for green projects and that all designated green projects should provide clear environmental benefits, which will be assessed, and where feasible, quantified, measured and reported by a borrower.
Further, green loans are required to be aligned with the following four (4) core components:
(a) use of proceeds: the fundamental determinant of a green loan is the utilisation of the loan proceeds for green projects which contribute to environmental objectives and should be appropriately described in the finance documents and, if applicable, marketing materials.
(b) process of project evaluation and selection: for the purposes of determining that the financing falls within the parameters of a green loan, the borrower shall clearly communicate to the lender(s), (i) its environmental sustainability objectives of the green projects; (ii) the process by which the borrower determines how its projects fit within the categories of eligibility for green projects; and (iii) the complementary information on the processes by which the borrower identifies and manages environmental and social risks associated with the relevant project(s).
(c) management of proceeds: the proceeds of a green loan should be credited to a dedicated account or otherwise tracked by the borrower in an appropriate manner, so as to maintain transparency and promote the integrity of the product.
(d) reporting: borrowers should make and keep readily available up to date information on the use of proceeds to be renewed annually and until the green loan is fully drawn (or until the loan maturity in the case of a revolving credit facility), and on a timely basis in the event of material developments.
The social loan market aims to facilitate and support the key role that credit markets can play in financing the mitigation of social issues and challenges, and/or the achievement of positive social outcomes.
Social loans are defined as any type of loan instrument and/or contingent facilities (such as bonding lines, guarantee lines or letters of credit) made available exclusively to finance, re-finance or guarantee in whole or in part, new and/or existing eligible social projects and which are aligned to the four core components of the Social Loan Principles. While the Social Loan Principles do not entail a fixed definition of what constitutes a social project, the Social Loan Principles provide that “Social Projects” will often fall within the non-exhaustive list of indicative categories of eligibility for social projects set out in the Social Loan Principles. Social projects directly aim to address or mitigate a specific social issue and/or seek to achieve positive social outcomes. For example, affordable basic infrastructure (e.g., clean drinking water, sanitation, transport, energy, basic telecommunications), affordable housing and food security.
Further, social loans are required to be aligned with the following four (4) core components which echo the Green Loan Principles:
(a) use of proceeds: the fundamental determinant of a social loan is the utilisation of the loan proceeds for social projects (including other related and supporting expenditures, including research and development), which should be appropriately described in the finance documents and, if applicable, marketing materials.
(b) process of project evaluation and selection: for the purposes of determining that the financing falls within the parameters of a social loan, the borrower shall clearly communicate to the lender(s), (i) the social objective(s) and the target population of the social projects; (ii) the process by which the borrower determines how its projects fit within the categories of eligibility for social projects; and (iii) complementary information on the processes by which the borrower identifies and manages social and environmental risks associated with the relevant project(s).
(c) management of proceeds: the proceeds of a social loan should be credited to a dedicated account or otherwise tracked by the borrower in an appropriate manner, so as to maintain transparency and promote the integrity of the product.
(d) reporting: borrowers should make and keep readily available up to date information on the use of proceeds to be renewed annually and until fully drawn (or until the loan maturity in the case of a revolving credit facility), and on a timely basis in the event of material developments.
Sustainability-linked loans aim to facilitate and support the key role that credit markets can play in funding and encouraging borrowers to contribute to sustainability (from an environmental and/or social and/or governance perspective). For such a role to be played and the market to thrive, integrity is of the utmost importance.
In contrast to green loans and social loans, sustainability-linked loans are any types of loan instruments and/or contingent facilities (such as bonding lines, guarantee lines or letters of credit) for which the economic characteristics can vary depending on whether the borrower achieves ambitious, material and quantifiable predetermined sustainability performance objectives. The borrower’s sustainability performance is measured using predefined sustainability performance targets (“SPTs”) as measured by predefined key performance indicators (“KPIs”).
(a) selection of KPIs: sustainability-linked loans look to support a borrower’s efforts in improving its sustainability profile over the term of the loan by aligning the terms of the loan to the borrower’s performance which is measured using one (1) or more sustainability KPIs that can be external/internal. The KPIs must be:i. relevant, core and material to the borrower’s overall business, and of high strategic significance to the borrower’s current and/or future operations; ii. measurable or quantifiable on a consistent methodological basis; andiii. able to be benchmarked (i.e. as much as possible using an external reference or definitions to facilitate the assessment of the SPT’s level of ambition).
A clear definition of the KPI(s) should be provided by the borrower and should include the applicable scope or parameters, as well as the calculation methodology, a definition of a baseline and be benchmarked against an industry standard and/or industry peers where feasible
(b) calibration of SPTs: the process of calibration of SPTs per KPI is key to the structuring of sustainability-linked loans, since it will be the expression of the level of ambition the borrower is ready to commit to. The SPTs must be set in good faith and remain relevant (so long as they apply) and ambitious throughout the life of the loan. It is therefore recommended that an annual SPT should be set per KPI for each year of the loan term.
(c) loan characteristics: a key characteristic of a sustainability-linked loan is that an economic outcome is linked to whether the selected predefined SPTs are met. For example, the margin under the relevant loan agreement will often be reduced where the borrower satisfies a pre-determined SPT as measured by the pre-determined KPIs and vice versa, and, in some cases, where a strong rationale is provided, the ratchet may include a neutral bracket in which no margin adjustment applies.
(d) reporting: borrowers should, at least once per annum, provide the lenders participating in the loan with, an up-to-date information sufficient to allow the lenders to monitor the performance of the SPTs and to determine that the SPTs remain ambitious and relevant to the borrower’s business; and a sustainability confirmation statement with verification report attached, outlining the performance against the SPTs for the relevant year and the related impact, and timing of such impact, on the loan’s economic characteristics.
(e) verification: borrowers must obtain independent and external verification of the borrower’s performance level against each SPT for each KPI by a qualified external reviewer such as an auditor for any date/period relevant for assessing the SPT performance leading to a potential adjustment of the SLL economic characteristics, until the last SPT trigger event of the loan has been reached.
The fundamental determinant of a green or social loan is the utilisation of the loan proceeds for green or social projects and the other core criteria set out in each of the Green Loan Principles and the Social Loan Principles must also be met.
Contrasting to green and social loans, the focus in relation to sustainability-linked loans is on supporting a borrower in improving its sustainability performance, through the achievement (or not) of predetermined SPTs. Therefore, the proceeds may be used to finance any kind of business activities that the borrower is pursuing, be they project based, or acquisition based.
As increasingly important areas of financing, it is essential to understand the characteristics of green loans, social loans and sustainability-linked loans as such loans provide for multiple benefits including a positive impact on the environment and/or climate change mitigation and/or adaptation. As banks are keener to provide such loans, companies are also increasingly devising sustainability strategies and incorporating them into their business strategies.
For further information,please contact Rafiq Jaffer, Natalia Kumar or Faizan Toor.
Published in June 2023
