An introduction to loans linked to sustainable development – Finance and banking


introduction

In recent years, borrowers and lenders have increasingly recognized the benefits of sustainability-related loan products. Sustainability loans align the cost of borrowing with the borrower’s performance as measured against prescribed sustainability performance goals. Unlike so-called green loans – which also aim to promote sound environmental practices – the borrower is not limited in its use of the loan proceeds only to green projects with obvious environmental benefits. But the borrower must conduct its business in a way that achieves ambitious but achievable sustainability performance goals. If a borrower meets these sustainability goals, there is a haircut – or, if the borrower does not meet the goal, a premium – on the borrower’s cost of borrowing.

Sustainable financing can be attractive to commercial and investment banks who want to be seen by the public, their shareholders and other stakeholders as having a commitment to good corporate citizenship. For borrowers wishing to bet on improving their sustainability performance, this type of loan offers an additional financing route that may prove to be more economical than conventional alternatives.

Principles of sustainability loans

The cornerstone of a sustainability loan product is the formulation and monitoring of relevant sustainability goals. To this end, sustainability-related lending principles were published in March 2019, followed by guidance published in May 2020, by the Loan Syndications and Trading Association in collaboration with the Loan Market Association and the Asia Pacific Loan Market Association. These principles establish a voluntary, high-level framework for sustainability-linked lending, based on four main elements, and give market participants the flexibility to tailor the principles to the particular circumstances of the borrower and their industry.

The first component discusses the relationship between sustainability goals and a borrower’s overall corporate social responsibility strategy. A borrower’s sustainability goals should be clearly communicated to their lenders and should align with their proposed goals. Borrowers should also disclose any third-party sustainability standards or certifications they seek to adopt for their corporate social responsibility strategy.

The second component aims to establish performance targets for sustainability. The objectives are generally formulated through negotiation between the borrower and his lenders on a case-by-case basis. Often, a “sustainability coordinator” or “sustainability structuring agent” is appointed to assist in the negotiation process. Goals should be (1) ambitious but meaningful to the borrower’s business, (2) linked to one or more predetermined benchmarks, and (3) based on recent performance levels. Targets can be either internal – based on the borrower’s internal corporate social responsibility strategy – or external, based on metrics established by organizations that assess this type of corporate behavior.

For example, sustainability-linked loans can be linked to an environmental, social and governance (ESG) rating. Penalties can be associated with a lower ESG rating, while a higher ESG rating can lower the cost of capital. Sustainalytics assesses a wide range of ESG categories that can be turned into targets, such as environmental and social impact of products or services, human rights, data privacy and security, business ethics, corruption, access to basic services, community relations, emissions, effluents and waste, carbon operations, human capital, land use planning and biodiversity, occupational health and safety, ESG integration, product quality and / or safety, resilience and resource use. Depending on the nature of the borrower’s business activity, certain subsets of these parameters may be incorporated into the sustainability performance goals of their loan facility.

The third element is geared towards reporting. Information regarding a borrower’s sustainability performance should be communicated to lenders periodically, at least once a year. The borrower is required to demonstrate compliance with sustainability performance objectives in sufficient detail, which includes an analysis of the methodology used to assess compliance and the underlying assumptions. Borrowers are often required to publicly disclose this information, which can be found in the borrower’s annual financial reports or in a dedicated sustainability report.

The fourth component is a review. Sustainability loans often provide for an external review of compliance. Whether a loan will require an external review is a matter of negotiation between a borrower and its lenders, but sustainability lending principles strongly recommend an external review when information regarding the borrower’s achievement of its goals. are not accessible to the public. Regardless of whether or not an external review is required, a borrower should have internal controls in place to verify the calculation of its sustainability performance.

An example: NRG Energy

In June 2016, NRG Energy Inc., the leading integrated electricity company in the United States, signed a $ 1.9 billion term loan and revolving credit facility. Facility sustainability performance goals relate to the reduction of carbon dioxide, methane and nitrous oxide emissions (known as greenhouse gas or GHG emissions) from fuel combustion in plants. boilers, turbines and motors used for the production of wholesale electricity in facilities owned or controlled by the borrower and its subsidiaries. In its 2019 Sustainability Report, published in May 2020, NRG Energy declared its commitment to meet GHG emissions reduction targets and target a 50% reduction by 2025 and net zero emissions by 2050, based on a 2014 baseline. NRG reported that its 2019 GHG emissions decreased by 41% since 2014.

Under the terms of the NRG facility, the applicable margin for term and revolving loans is adjusted based on the performance of so-called KPI measures against a benchmark sustainability amount, as indicated in the benchmark annual sustainability report. of the borrower and audited by an independent body recognized at national level. public accountants. KPI indicators measure (i) total annual GHG emissions in millions of metric tons (mTCO2e) and (ii) Carbon intensity of revenues, an amount equal to the amount of GHG emissions divided by the total operating revenues of the borrower and its subsidiaries. The benchmark for sustainability is 46 million mTCO2e and 4628 mTCO2e / $ M, respectively. For example, if both KPIs are greater than 110% or less than 90% of the applicable benchmark durability amount, the applicable margin will be adjusted upward or downward by 30 basis points, respectively.

Conclusion

Sustainable development loans have become increasingly popular in recent years. Refinitiv, a global provider of syndicated loan and high yield bond market information, reported that a combined $ 167 billion in green loans and sustainability-linked loans entered the global lending market in 2019, an increase of 150% compared to the previous year. Over the past year, COVID-19 has disrupted financial markets and held back the growth of sustainability-linked lending, but it appears that enthusiasm for sustainability-linked lending remains high. With the growing prevalence of ESG and similar investment programs in the financial markets, it can be expected that institutional lenders will become more and more open to providing loans linked to sustainability. Borrowers can also look for these loans more and more because not only do they give a picture of social responsibility, but they also offer the possibility of lowering the cost of capital of a successful borrower.

The content of this article is intended to provide a general guide on the subject. Specialist advice should be sought on your particular situation.


About Matthew Berkey

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