What are Sustainability-Linked Loans?
Sustainability-linked loans (“SLLs”) are similar to normal credit facilities, but typically the interest payable is linked to selected sustainability key performance indicators (“KPIs”) i.e. environmental, social and governance (“ESG”) targets, designed to incentivise the borrower. Borrowers that achieve their sustainability targets benefit from more favourable interest rates, whereas failure to meet the targets leads to higher interest rates. The borrower therefore has an incentive to ensure that its loan terms and its sustainability objectives marry up to achieve the favourable interest rates.
Historically, “green loans” have been used to purchase, for example, green assets such as energy efficient plant and machinery. However, with SLLs, the purpose of the loan does not have to be “green” and now we are seeing these types of loans being used for unspecified uses. Companies are using SLLs for general corporate purposes (usually via revolving credit facilities) to incentivise the borrower’s commitment to sustainability and often to support environmentally and socially sustainable economic activity and growth. Within the European Union, French, Spanish and Nordic banks seem to have taken the lead with SLLs and the market is constantly expanding. We understand $34billion of these loans were advanced last year with 70% being green financing i.e. green loans and green bonds.
Companies that have recently entered into SLLs include:
- Masmovil Ibercom SA, who carried out an SLL financing last year with BNP Paribas. This was the first European leveraged loan with an ESG component and was used to finance a telecoms project with social objectives. The loan revolving credit facilities and capital expenditure lines were tied to ESG KPIs, using ESG rating from Standard & Poor’s to ratchet the pricing of the loan up or down by 15 basis points;
- The Pearson Group, which became the first education company to link an SLL to education targets; and
- Thames Water, a UK utility company, completed a SLL which linked its borrowing to the GRESB Infrastructure Score, an ESG benchmark for infrastructure assets.
So what are the benefits?
Apart from obtaining the obvious preferential interest rates, SLLs can be seen as the first step in a borrower’s journey towards, and a demonstration of their ongoing commitment to, becoming more sustainable. SLLs enhance the relationship between borrower and lender, because the borrower becomes more open about their commitments and company information when looking to set and monitor their ESG targets.
How easy is it to prepare loan documentation using these KPIs?
Documenting these loans does not need to be overly complicated. Lenders tend to look at a borrower’s ESG rating as a way to structure the loan. A lender may choose to set the loan's interest rate to the company's ESG rating or use the ESG rating as a performance target within the terms of a loan.
More and more companies are looking to SLLs to (a) enhance their ESG credentials, (b) show a top-down commitment to ESG improvements, and (c) open the line of communication with their employees for ESG initiatives- as management has to have an ongoing dialogue with the workforce for the process to work well.
Jonathan Porteous, Head of Banking and Finance at Stevens & Bolton comments that:
“SLLs could become fundamental to company decision-making and investment. We also anticipate that investors will place increasing importance on portfolio companies adopting and adhering to an ESG strategy”.