As environmental, social and governance (“ESG”) initiatives are increasingly implemented by borrowers and lenders, sustainability-linked lending offers opportunities for both.
What are sustainability-linked loans?
Sustainability Linked Lending (“SLL”) is based on the Sustainability Linked Lending Principles developed by the LMA, APLMA and LSTA. In SLLs, a borrower, together with its lender group, determines and sets certain sustainability performance objectives (“SPTs”) that the borrower must achieve, to be measured by key performance indicators (“KPIs”). ). Independent organizations, including the Sustainability Accounting Standards Board (“SASB”), provide guidance on the most relevant ESG measures for certain industry sectors. Once agreed between the borrower and lenders, the KPI/SPT benchmarks are then incorporated into the interest rate or commitment fee margin adjustments for the credit facility (i.e. ‘by reaching the KPIs, the interest rate is reduced). The credit facility documentation will also include reporting requirements for independent external verification of the Borrower’s level of performance against each SPT for each KPI, at least annually.
Benefits for the borrower
Many companies have already undertaken ESG data collection and reporting, and more will likely do so as the SEC expands its focus on ESG disclosures and more investors demand this information. While the third-party verification and reporting costs mentioned above are inherent to SLLs, borrowers who are already engaging in these efforts may find that they can effectively gain an additional economic incentive through SLL financing. Additionally, SLLs can be part of a full alignment with the borrower’s ESG strategies and policies.
Benefits of the lender
Lenders are also undertaking ESG initiatives, of which SLLs can be a component. Additionally, regulators of some lenders are communicating their plans to provide guidance on climate-related risks and incorporating these principles into their oversight expectations. Additionally, studies have shown that companies (e.g. SLL borrowers) that identify and manage their ESG risks have improved financial performance. Thus, SLL financing can benefit lenders in all political, regulatory and commercial aspects.
Current state of the market and next steps
Although SLLs are a relatively new financing concept, particularly in the United States, the volume of SLLs issued globally has quadrupled between 2020 and 2021. As ESG momentum continues to strengthen in the United States, the volume of SLL should also continue to grow. Currently, terms are negotiated on a transaction specific basis and market provisions have not been added as a result of LSTA documents. But, as SLLs become more common, the market is likely to merge on terms. Stay tuned for more updates on SLLs and other trending sustainable finance products, including Green Bonds and Commercial Property Assessed Clean Energy Finance (C-PACE).