In our latest editions of REF News & Viewswe introduced the Green Lending series of articles in which we discussed the emergence of “green lending” and the principles of green lending – those principles that form the proposed framework for standards, guidelines and methodology to adopt in the green loan market.
In the next series of articles, we want to focus on sustainability-linked lending (“SLL”), which has also emerged alongside green lending as a result of the movement towards greater awareness and improved outcomes. environmentally and socially beneficial in how companies and lenders affect their lending, investment and other business decisions. While green loans and SLLs are similar in their macro mission towards environmental and social sustainability, there are important differences in their approach. We seek to explore this in more detail in this series of articles on sustainability-related lending.
What is a sustainability linked loan?
SLL is defined as any type of loan instrument and/or conditional facility (for examplesurety line, guarantee line, letter of credit) that incentivizes the borrower to achieve ambitious and pre-determined sustainability performance targets.
Borrower sustainability performance is measured using Sustainability Performance Objectives (“SPTs”), which may include Key Performance Indicators (“KPIs”), external ratings and/or or equivalent metrics that measure improvements in the borrower’s sustainability profile. These may include measures related to issues such as energy efficiency or the 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:
- Objective: There is no product use requirement for an SLL; in fact, many SLLs on the market are for general purpose business lending. Instead, SLLs seek to improve the borrower’s sustainability profile by aligning loan terms with borrower performance against relevant SPTs. This contrasts sharply with green loans, which are primarily categorized by how the proceeds are used for a qualifying green project, i.e. the underlying investment of the green project, the management of the proceeds and reporting.
- Pricing: A key incentive for a borrower to enter into an SLL is the price adjustment that may be granted to them based on their performance against an agreed set of key performance indicators and SPTs, external ratings and/or equivalent measures. The principle is therefore that if the borrower achieves the agreed objectives, then the margin on the loan will decrease accordingly. It is also often set to work in reverse, so if the borrower fails to meet their targets, the margin will increase.
- Flexibility: By focusing on general performance as opposed to a specific project itself, SLLs offer greater flexibility in their application and use case, opening up the green and sustainable lending market to a wider range of companies that would otherwise not have projects specific to a green project.
In the next article in this series on sustainability-linked lending, we will present the principles of sustainability-linked lending, which have been published to provide a framework to help market participants understand and identify the key elements of sustainability. establishment of sustainability-linked loans.