Sustainable development loans – Lexology

This article is the second in a series of articles on the evolution of ESG in debt financing (the first is available here). In this article, we touch on the topic of sustainability related loans. Before we get into the details and trends, we will briefly discuss the difference between sustainability loans and green loans. In the following articles in this series, we will examine the evolution of ESG and green debt in the USPP, DCM and securitization markets.

Sustainable development loans have a much broader application than green loans (loans set up to be used for a specific “green” purpose). Typically, sustainability-related loans can be used for general corporate purposes, are industry independent, and often focus as much on the societal and governance aspects of ESG as on the environment.

The development of loans linked to sustainable development

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On the lending side, LMA, APLMA and LSTA have jointly developed lending principles related to sustainability. It is a set of high-level market standards aimed at promoting the development and integrity of sustainable lending by encouraging consistency of approach while recognizing the need for flexibility between sectors. In practice, however, the sustainability conditions of a financing focus on the company’s ESG framework and objectives, not least because the principles focus only on environmental factors. Discussions with lenders on ESG usually take place in this specific context rather than by reference to the above principles, but it is certain that ESG advisers and coordinators will take these principles into account when advising on related features. sustainability of funding. .

ESG framework and monitoring of performance objectives in terms of sustainable development

Corporate sustainability loans will generally build on the borrower’s existing ESG framework as disclosed in the borrower’s audited financial statements. This approach greatly simplifies not only the agreement on the loan agreement provisions related to sustainability, but also the continuous reporting against the Sustainability Performance Targets (“SPT”). It also avoids the need for continuous monitoring of SPTs by a lender or other third party. There is a large and growing industry of SPT advisers and watchdogs that borrowers turn to to help them verify SPT’s performance. This is then reflected in the audited financial statements rather than in separate reports to lenders.

Structure of sustainability loans

Sustainability Loans are typically structured as a general business revolving credit facility, with a small additional pricing advantage to the borrower for achieving certain sustainability goals. The objectives fall broadly into two categories:

1. the obligation for the borrower and its lenders to define ambitious and meaningful baseline SPTs which the borrower must adhere to and which correspond to its own broader sustainability goals; and

2. the need for transparency in determining whether these SPTs have been met by both borrower reporting obligations and objective SPTs.

From a documentary point of view, there is no standard market model for financing linked to sustainable development. However, a number of key trends have developed in the market and the time spent in a transaction on sustainability aspects tends to be spent on approving the SPTs themselves rather than documenting them.

Key performance indicators

The borrower’s sustainability performance is typically measured using specific SPTs that measure improvements in the borrower’s sustainability goals (rather than a more generic ESG score). These must be real, rigorous and measurable objectives to avoid the risk of “greenwashing” (that is to say the setting of objectives which, if achieved, would not reflect material improvements in the future. beyond current performance). Borrowers can expect lenders to test the degree of requirement of SPTs and insist that SPTs focus on significant incremental improvements beyond the current baseline. Considering this:

  • it is customary to select sustainability objectives which are already reported in the audited consolidated annual accounts of the borrower / its parent company;
  • environment-related SPTs that are set at a level that is “only a little better than last year” are likely to be challenged by lenders. From a political and reputational perspective, lenders naturally strive to avoid the risk of being associated with greenwashing; and it is common for a borrower who concludes their first sustainability loan to appoint a lender as the ESG coordinator. It is advisable that discussions with the ESG coordinator start early in any funding process. This coordinator assists the borrower in:
    • define the SPTs themselves and the projected target performance (which will generally be derived from the company’s ESG framework);
    • agree on sustainable development provisions to be included in the installation agreement; and
    • liaise with syndicate lenders and assist the borrower in answering syndicate questions related to sustainability.

Number and types of PTS

We commonly see three agreed SPTs for sustainability-linked lending (sometimes more depending on the borrower’s ESG framework (e.g. five)). The following are examples of recently agreed SPTs:

  • reduce greenhouse gas emissions;
  • percentage of women in managerial positions;
  • employee training on:
    • the diversity;
    • anti-harassment; and
    • culture;
  • provision of educational services;
  • the use of more energy and water efficient processes or machines;
  • use of renewable energies;
  • reduce workplace injuries;
  • create a “do the right thing” corporate culture; and
  • promote new innovations.

When writing SPTs, it is important to be clear about the mechanism by which the borrower’s improvement is measured, for example, whether improvement is to be defined as a change in the absolute value of the metric, or as a percentage change.

SPT performance reports to lenders

Reports to lenders will usually take the form of a sustainability certificate which defines target and actual SPT performance, which is provided with the audited consolidated annual accounts of the borrower / its parent company and the certificate of compliance with financial commitments. The sustainability certificate will also indicate the margin adjustment (if any) that applies as a result of this performance. As SPTs are part of the audited financial statements, separate testing / reporting by a third party financial party / ESG advisor is generally not required.

The test of the future

SPTs may cease to be as relevant over time, and parties may need to consider modifying them, particularly for installations that have longer deadlines or options to extend. Some facilities include obligations to negotiate in good faith to modify SPT targets that were applicable after a certain period of time.

Borrowers should also consider the potential impact on SPTs of any changes to their business. The facilities may define the conditions under which the borrower may be allowed to update its SPTs to maintain alignment with its business and sustainability commitments, for example, in the context of a significant M&A activity, d ‘extraordinary events or changes in the regulatory environment. This is to ensure that the SPTs are neither more nor less demanding than they would have been without such an event, in the same way that the facility agreements contain similar provisions to reverse the effect of the accounting changes on financial covenants. To date this type of sustainability has been very limited but it is something that we expect to see more and more over time.

If third-party ESG ratings are used, borrowers should be aware of the possibility of rating agencies changing their rating methodologies, which Sustainalytics did last year. In such a circumstance, the facilities should contain provisions allowing the parties to review and accept changes to any affected SPT.

Consequences of non-compliance with SPTs

Failure to comply with all or part of the SPTs will not be an event of default, nor will the failure to deliver an SPT certificate. This will be explicit in the installation agreement (although it should be noted that a misrepresentation of SPT information may very well constitute a violation). The only direct consequence of achieving or not complying with SPTs or issuing an SPT certificate will be a margin adjustment. This would take effect shortly after the issuance of the SPT certificate or the last day after which an SPT certificate should be issued respectively.

It is typical to see “two-way” margin adjustments based on the number of SPTs encountered. Although this is a matter of negotiation, a common wording is as follows:

3 SPT achieved: margin reduced by 2.5bp

1-2 SPT encountered: no margin adjustment

0 SPT achieved or no certificate issued: margin increased by 2.5 bp

Normative payment provisions

It is also becoming increasingly common to include a scheme that requires the amounts represented by price changes on the loan to be applied in a specified manner (and not simply retained by the bank or borrower). For example, the borrower might agree to donate their margin savings to charity or reinvest them to meet SPT or other ESG goals. The approach of lenders to the application of an increased margin has been varied. For some, the perception of benefiting from non-compliance with SPTs has meant that either the lenders have (i) agreed to pay these increased amounts to charity or (ii) allowed the borrower to keep the increased margin. provided that it is applied to achieve SPT or other ESG objectives (provided that it is additional expenditure). Alternatively, and more generally, the facility agreement does not regulate how lenders will apply this increased margin.


The growth of sustainable business practices and their financing is widely seen as a key component of economic recovery from the CoVid-19 pandemic. While the short-term economic benefits of adopting sustainability provisions in business loans may be marginal given initial work and ongoing monitoring (especially for unused stand-by FCRs), economic factors, regulations and broader investors mean that, for many, sustainability – tied loans will quickly become the norm. This is a theme that we will take up in our 8th annual report on corporate debt and treasury, which will be published in the spring.

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