Through June and July 2022, the Loan Market Association (LMA) published a series of articles to bolster the integrity of the sustainability-linked loan product (SLLs) addressing issues regarding the setting of key performance indicators (KPIs) and sustainability performance targets (SPTs) as well as focusing on the issue of timing in negotiating SLLs. Then, on 12 July 2022, the LMA published an introductory guide to the sustainability coordinator role to increase market understanding of this role and how it fits within the broader sustainable lending context.
What is the LMA addressing?
The popularity of SLLs continues to rise. According to AFME data, sustainability-linked and green-linked loan issuance in the European market increased 106% year on year to €284bn in 2021 from €138bn in 2020. Sustainability-linked and green-linked loan issuance represented 25.4% of total European loan issuance during 2021, up from 13.9% in 2020.
This popularity and the ease of incorporating ESG elements in SLLs have given rise to concerns about “greenwashing”. The LMA’s express purpose in publishing the articles is to provide guidance on drafting SLLs to support the credibility and integrity of the product.
Factors to consider when negotiating SLLs
- The Sustainability-Linked Loan Principles published by the LMA state that the KPIs chosen must be “relevant, core and material” to the business of the borrower. While KPIs remain bespoke to each borrower, there would need to be a strong justification if different KPIs are chosen from those used by other borrowers in the same industry sector.
- A borrower should consider external assistance when choosing their KPIs, by appointing a sustainability coordinator to assist negotiation, hiring an ESG consultant to assist with overall strategy or approaching second party opinion providers, which we have generally seen in the bond market. The lenders themselves have a responsibility to challenge the materiality of the KPIs.
- Borrowers should consider all material KPIs, not just those commonly used due to availability of data. Environmental factors are still more often chosen over other elements of ESG, although we have increasingly found that borrowers are considering social and governance factors when selecting KPIs.
- The SPTs set for each KPI should be a “true reach” and ambitious. They should go beyond any regulatory requirements to show that the borrower is extending itself rather than operating in its usual course.
- The parties may consider requiring that the SPTs are never less than the borrower’s publicly announced targets, so that they can tighten if the borrower announces a more ambitious target. Other recalibration mechanics may also be considered to ensure that the SPTs remain relevant and challenging throughout the life of the SLL.
- Some SPTs may not be linear. If a variation in targets would maintain a genuine demand on the borrower, this should be recognised.
- Borrowers should not fear failure to meet the SPTs. This would reflect that the SPT was appropriately ambitious, not set incorrectly. Borrowers should not declassify then reclassify loans as SLLs to avoid missed SPTs.
- The parties should not underestimate the time needed for a borrower at the start of its ESG journey to negotiate its KPIs and related SPTs. The rigour of challenging and testing proposals should not be compromised just to achieve the status of an SLL.
As referred to above, we have found that both borrowers with existing sustainable finance products and those new to these products are appointing a sustainability coordinator (generally) from the lender group to assist the borrower and lenders in agreeing a syndicated SLL and align to market practice. Given the inconsistencies in terminology and approaches, the LMA published guidance to clarify the role.
A sustainability coordinator will provide assistance to meet the requirements of an SLL and negotiate the KPIs and SPTs. As they are appointed on a non-reliance basis, the parties will still need to make their own individual assessment. We have seen that borrowers can find them a valuable intermediary with the full lender group on the sustainability aspects of an SLL, but the parties still need to understand the requirements of the product themselves.
Given the various regulatory, market and other factors encouraging sustainable financing, the popularity of SLLs is unlikely to abate. The additional guidance and information for borrowers entering this market or developing their existing sustainable products will assist them achieve credible SLLs and maintain the integrity of the product despite new market participants.
As most borrowers seek to align their KPIs across their products, developments in ESG-related bonds should also be tracked. For example, there has been recent guidance from the International Capital Markets Association (ICMA) (please see ESG bonds – recent ICMA and FCA publications, Reena Parmar, Peter Allen, Duncan Kellaway (freshfields.com)) and the ICMA has published an updated registry of approximately 300 KPIs for sustainability-linked bonds, which might also be of interest to SLL borrowers.
We are working on a number of SLLs and other sustainable finance products for clients across the debt spectrum and would be happy to advise on the latest developments.