Sustainability Linked Loans Series, Part 1 – Introduction To Sustainability Linked Loans – Financial Services

In our last few editions of REF News and Views, we
featured the Green Loan Series of articles in which we discussed
the emergence of “green loans” and the Green Loan
Principles − those principles that form the proposed
framework for market standards, guidelines and methodology to be
adopted across the green loan market.

In the next series of articles, we want to focus on
sustainability linked loans (“SLLs”), which also emerged
alongside green loans as a result of the movement towards greater
awareness and improving environmentally and socially beneficial
outcomes in the way corporates and lenders effect their lending,
investment and other business decisions. Whilst green loans and
SLLs are similar in their macro mission towards environmental and
social sustainability, there are some important differences in
their approach. We look to explore this further in this
Sustainability Linked Loans series of articles.

What is a sustainability linked loan?

SLL is defined as any type of loan instrument and/or contingent
facility (e.g., bonding line, guarantee line, letter of
credit) that incentivises the borrower’s achievement of
ambitious, predetermined sustainability performance objectives.

The borrower’s sustainability performance is measured by
using sustainability performance targets (“SPT”), which
can include key performance indicators (“KPI”), external
ratings and/or equivalent metrics which measure improvements in the
borrower’s sustainability profile. These can include measures
related to matters such as energy efficiency or sustainable
sourcing of raw materials and supplies.

How are sustainability linked loans different from green
loans?

There are three key differences between SLLs and green
loans:

• Purpose: There is no use of proceeds
  requirement for an SLL; in fact, many SLLs in the market are for
  general corporate purpose loans. Instead, SLLs look to improve the
  borrower’s sustainability profile by aligning loan terms with
  the borrower’s performance against the relevant SPTs. This is
  in significant contrast to green loans, which are principally
  categorised by the way in which the proceeds are used towards an
  eligible green project − that is, the underlying green
  project investment, the management of the proceeds, and
  reporting.




• Pricing: A key incentive for a borrower in
  entering into an SLL is the pricing adjustment that can be awarded
  to it based on its performance against an agreed set of KPIs and
  SPTs, external ratings and/or equivalent metrics. The principle
  therefore is that if the borrower meets the agreed targets, then
  the margin on the loan will decrease accordingly. It is often set
  to work in reverse, also, such that if the borrower fails to meet
  its targets then the margin will increase.




• Flexibility: With the focus on general
  performance as opposed to a specific project itself, SLLs provide
  greater flexibility in their application and use case, opening up
  the green and sustainable loans market to a broader range of
  companies that may not otherwise have any projects that are
  specific to a green project.

In the next article in this Sustainability Linked Loans series,
we will introduce the Sustainability Linked Loan Principles, which
were published in order to provide a framework to help market
participants understand and identify the key components in
establishing sustainability linked loans.

The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.