Sustainable Finance: Green Loans and Sustainability-Linked Loans
Fernando Rodriguez Marin, a partner in Bracewell’s New York office, provides insight on two of the newest sustainable finance products in the market: green loans and sustainability-linked loans...
The New York-based Loan Syndications and Trading Association (LSTA), together with the London-based Loan Market Association and its Asia-Pacific peer, the Asia Pacific Loan Markets Association, have jointly issued principles and guidance on two of the newest sustainable finance products in the market: green loans and sustainability-linked loans.
The defining characteristic of a green loan is the specific use of loan proceeds which must be dedicated exclusively for green projects.
A green loan must contain mechanisms to facilitate the borrower to periodically report of the actual use of proceeds and the lenders to verify the agreed use of the proceeds. In contrast, sustainability-linked loans, also known as ESG-linked loans or KPI loans, or other denominations, apply to any type of loan instruments, any type of contingent facilities and similar instruments, and permit loan proceeds to be applied for a company’s general purposes. The defining feature of these loans is that the borrower’s compliance with pre-agreed sustainability performance targets has a partial impact on the pricing of the loan. Thus, a borrower may see an increase or reduction on the margin depending on the degree by which it meets or exceeds such targets or improves its ESG rating.
According to the LSTA guidance, sustainability-linked loans must comply with the following principles.
First, the borrower must have an existing sustainability strategy with which the proposed loan aligns. This is the same requirement as for green loans.
Second, the targets must be ambitious and meaningful to the borrower’s business and should be tied to a sustainability improvement in relation to a predetermined performance target benchmark, such as targets or metrics included in the borrower’s own policies or industry metrics and scoring systems. In other words, the targets must represent a reach for compliance by the borrower.
Third, borrowers must report on their progress on achieving their targets at least annually.
And fourth, depending on the circumstances, the borrower’s performance may need to be reviewed by an independent reviewer or auditor.
In sum, before considering green loan or sustainability-linked loan financing, a company should first establish credible and verifiable ESG policies and commit to including such policies as an integral part of their business processes.