The worldwide market of green and sustainable finance is flourishing. As companies and lenders worldwide increasingly try to integrate sustainability into their business processes, the volume of sustainable debt issued globally has shown a spectacular growth over the last few years, with a total volume of $465 billion globally in 2019, according to BloombergNEF.¹  

While it is, of course, hard to tell what the overall impact of the current Covid-19 crisis will be, it seems safe to presume that the green and sustainable finance market will continue to grow as companies will more than ever focus on tackling environmental, social and governance (ESG) challenges to safeguard their businesses.  

Whereas up until recently “green” and “sustainable” projects were funded primarily by means of green bonds – securities with proceeds that are used entirely for climate and environmental projects – the global market for green and sustainable finance has developed various innovative financing mechanisms, providing borrowers with flexible solutions to integrate environmental or sustainable targets into their business operations and funding. 

While green bonds still constitute more than half of the entire sustainable debt market in 2019, the relatively new product of sustainability-linked loans – loans linked to the borrower’s performance on defined environmental, social or governance (ESG) criteria – have quickly gained much popularity with a total volume of $122 billion in 2019, according to BloombergNEF. 

Up to now, there have been no real “market standard” forms of green or sustainable loans nor any “market standard” provisions that are typically used for such loans. As a point of reference, the Loan Market Association (LMA), in joint cooperation with the Asia Pacific Loan Market Association and the Loan Syndications and Trading Association, has published the Green Loan Principles (GLP) and the Sustainability Linked Loan Principles (SLLP). 

The GLP and the SLLP have been developed by experienced working parties, consisting of representatives from leading financial institutions active in the global syndicated loan market. The ultimate goal of each of the principles is to provide for a globally acceptable approach for granting green and sustainable loans to better facilitate and support environmentally and sustainable economic activity as well as to promote the development and preserve the integrity of the green loan and sustainability-linked loan products. The GLP and SLLP are both voluntary recommended guidelines, which – depending on the underlying characteristics of the transaction – are to be applied by market participants on a deal-by-deal basis. 

Since the launch of the GLP in 2018 and SLLP in 2019, market participants have sought further explanation on the practical application of the GLP and the SLLP to their transactions. As a response, earlier this month, the global loan market associations published two new guidance documents in which some of the most frequently asked questions in relation to the GLP and SLLP have been addressed.

In this article, we look a bit more in details at the core components of the GLP and the SLLP, and how these principles are applied in practice. 

GLP principles 

The GLP provide for the following definition as to what a green loan is: “Any type of loan instrument made available exclusively to finance or re-finance, in whole or in part, new and/or existing green projects”. In the appendix to the GLP a non-exhaustive list of categories of green projects is provided, including sustainable water and wastewater management, clean transportation and green buildings. Furthermore, according to the GLP green loans must align with the following four components: (table below).

SLLP principles

According to the SLLP, sustainability-linked loans are: “Any types of loan instrument and/or contingent facilities (such as bonding lines, guarantee lines or letters of credit) which incentivise the borrower’s achievement of ambitious, predetermined sustainability performance objectives.”

In the appendix to the SLLP, a non-exhaustive list of categories of sustainability performance targets (SPTs) is provided, including energy efficiency, affordable housing and biodiversity. 

Similar to green loans, sustainability-linked loans must align with four components: (table below)

Sustainable loans in practice

Although there are no real “market standard” forms of green or sustainable loans nor any “market standard” provisions that are typically used for these loans, in practice we commonly see the following provisions in standard loan documentation adjusted.

Purpose clause

The purpose clause in loan documentation is of particular importance when it comes to green loans. As one of the core components for green loans, the loan documentation should clearly indicate for which green project(s) the loan proceeds will be utilised. Any breach of the purpose or use of proceeds provisions should be taken seriously and the loan should not be considered green from the date of occurrence of such event, subject to any cure rights.

If the green loan takes the form of a revolving credit facility, the use of proceeds component may be less detailed compared to term loans, as long as the purposes of the revolving credit facility fall within the scope of the GLP. Tracing the proceeds of a revolving credit facility may be facilitated by structuring the facilities into separate tranches; for example, by splitting the revolving facility into tranches for general corporate purposes and for green purposes. Only the green tranches will be classified as green. 

The focus of sustainability-linked loans is on the performance of the borrower’s SPTs, rather than the use of proceeds. Contrary to green loans, sustainability-linked loans may be used for general corporate purposes.

Margin adjustments

A green or sustainability-linked loan is in principle priced in the same way as any other loan. However, green or sustainability-linked loans characteristically try to incentivise borrowers to achieve ambitious, predetermined environmental sustainability objectives or SPTs. If targets are met then the margin will be reduced; if not, then the margin increases. Often grids with various margin criteria are being used, where the margin further declines if more targets are met (or vice versa if more targets are missed). The mechanism for the measurement of the borrower’s improvement against the predetermined environmental sustainability objectives or SPTs must be carefully considered and should be documented in the facility agreement.

Information undertakings/conditions precedent

Reporting is a core component under the GLP and SLLP. Borrowers should provide their lenders annually with up-to-date information on the use of green loan proceeds and the achieved impacts in respect of the agreed environmental sustainability objectives or SPTs. Such ongoing reporting will typically follow the usual reporting that borrowers would be expected to do under their information undertakings. 

Although the GLP and SLLP do not prohibit internal review and self-certification, lenders often require external review of (part of) a borrower’s green loan framework or SPTs to ensure alignment with the GLP or the SLLP. Several types of external review are being provided by consultants, institutions or other qualified parties. The required external review will become a condition precedent to the relevant loan being made available. An important goal for the development of the green and sustainable loan market is to build more confidence in external reviews and certifications. For this, appropriate standards will need to be developed that are consistently applied across transactions.  

Undertakings/representations

Green or sustainability- linked loans contain certain specific covenants or representations including (i) an undertaking that the value of the relevant green assets (for example: windmills or waste disposal systems) will always be higher than the proceeds drawn under a green loan; (ii) an undertaking that the agreed environmental objectives or SPTs will be met; or (iii) an undertaking / representation that the proceeds of a green loan will be utilized for specific green projects. 

The consequences of not complying with any such undertaking / representation differs. For borrower-friendly loans, failing to comply with the relevant undertaking / representation only impacts the pricing, and a higher margin will be applicable. However, for lender-friendly loans, failure to comply with green or sustainable undertakings / representations may have further implications, such as a draw stop for new funds or triggering a default, pursuant to which lenders may use their usual acceleration rights. 

Conclusion

As more and more companies look at integrating sustainability into their business processes and strategy there is still much room for growth in the green and sustainable finance market. Without doubt the Covid-19 crisis will, next to short-term headwinds, generate strong tailwinds for sustainability efforts of companies. It seems evident that the loan market will continue to innovate in structuring the terms of financings to play its part in this development. We expect that a variety of green loans and sustainability-linked loans, as well as multiple ways in which the GLP and SLLP are applied in the relevant loan documentation will continue, as each sector, borrower or asset class has different characteristics, requiring tailor-made approaches. 

¹ https://about.bnef.com/blog/sustainable-debt-sees-record-issuance-at-465bn-in-2019-up-78-from-2018/