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By: Amara Gossin, Barclays and Bob Lewis Sidley, Austin LLP
Sustainability-themed debt instruments represent one response of the financial community to the need to channel capital towards facilitating a carbon transition. Since green bonds debuted in 2012, the types and numbers of these instruments have grown.
ONE OF THE NEWEST ENTRANTS TO THE MARKET IS sustainability-linked loans, which first began to appear in 20171 and have become mainstream following the publication of the Sustainability Linked Loan Principles (the Principles) in March 2019 by the Loan Syndications and Trading Association, the Loan Market Association, and the Asia Pacific Loan Market Association, the loan industry bodies in the United States, United Kingdom and Asia Pacific, respectively.
This article provides a brief summary of some key features, benefits, and drafting considerations of sustainability-linked loans.
A sustainability-linked loan is a loan or similar facility that includes an economic incentive for the borrower to achieve certain defined sustainability performance targets (for example, increasing the percentage of power generated by a utility from renewable sources or increasing the certified-sustainable space operated by a real estate operator). This incentive typically takes the form of a secondary pricing mechanism that adjusts pricing up or down depending upon the borrower’s performance of the sustainability targets. Aside from that pricing incentive, the sustainability-linked loan is largely identical to any other loan product or contingent facility and may be used for any purpose (including general corporate purposes). In contrast, a green bond, green loan, or similar sustainability-themed debt instrument focuses on the proceeds of the debt being used for sustainable purposes.
The four components of a sustainability-linked loan set out in the Principles are the following:
Companies are increasingly focused on integrating sustainability considerations into their core businesses—whether because of strategic decisions or in response to pressure from investors, regulators, employees, customers, local communities, or other stakeholders. Sustainability-linked loans allow companies to demonstrate their commitment to achieving key sustainability-related performance targets by tying loan pricing to their achievement. This sends a powerful message of alignment across a company’s core business, contrasting this integration to the historic treatment of sustainability as the purview of a single team or business area. At the same time, by linking the incentive to pricing rather than a more damaging event of default, the company can set ambitious targets without significant contractual risk. In addition, achievement of the sustainability targets results in a pricing benefit.
To date, sustainability-linked loans have been made in relationship-based revolving credit facilities. In these cases, lenders expect a long-term working relationship with the borrower. Helping the borrower to achieve its sustainability-related business targets is an important part of that relationship. These loans are also responsive to stakeholders’ demands that lenders be well-positioned to address the economic impact of environmental change on their loan portfolio. The more lenders encourage clients to consider and prepare for these economic costs, the stronger the lenders’ portfolios are likely to be in the face of it.
Proper drafting and structuring of sustainability-linked economic incentives into general-purpose loan documentation can have a material impact on both the borrower’s and its creditor’s environmental, social, and governance objectives. If done well, the structure can be straightforward from a legal perspective. Moreover, such financings facilitate the integration of sustainability metrics with business metrics and can send a powerful message to both the borrower’s and creditor’s stakeholders. Done poorly, sustainability-linked mechanisms may risk opening borrowers or lenders to charges of greenwashing for seeking the public relations benefits of a purportedly greener type of loan without attendant meaningful business change.
Amara Gossin is Vice President, Legal at Barclays in New York, where she advises the U.S. corporate bank on its transactions and strategic activities. She is co-founder and co-chair of the bank’s employee environment network in the Americas and advised the bank from an in-house legal perspective on the first sustainability-linked loan facility completed in the United States. Prior to Barclays, Amara practiced in the bank finance group at Weil, Gotshal & Manges LLP in New York. Bob Lewis is head of Sidley Austin’s Chicago Global Finance practice. Bob focuses his practice on representing clients in the global financial services industry. Bob assists with structuring, negotiating, and administering syndicated financings, structured finance transactions, corporate restructurings, and workouts in a variety of industries and sectors. Bob has acted as counsel to the lead arrangers in connection with several initial sustainability-linked syndicated loan transactions in the United States in both the power and utilities sector (CMS Energy, Consumers Energy) and the REIT sector (HCP).
To find this article in Lexis Practice Advisor, follow this research path:
RESEARCH PATH: Finance > The Credit Agreement > The Loan > Practice Notes
For an overview of sustainability-linked loan principles, see
> MARKET TRENDS 2018/19: SUSTAINABILITY LINKED LOAN PRINCIPLES
RESEARCH PATH: Finance > Trends and Insights > Market Trends > Practice Notes
For a discussion of sustainability reporting, see
> CORPORATE SUSTAINABILITY
RESEARCH PATH: Capital Markets & Corporate Governance > Corporate Governance and Compliance Requirements for Public Companies > Corporate Governance > Practice Notes
For an introduction to renewable energy projects, see
> RENEWABLE ENERGY FINANCE
RESEARCH PATH: Finance > Project Finance > Renewable Energy > Practice Notes
For a review of corporate social responsibility concepts, see
> CORPORATE SOCIAL RESPONSIBILITY AND THE SUPPLY CHAIN
RESEARCH PATH: Corporate Counsel > General Commercial Agreements > Distribution Agreements > Practice Notes
For an explanation of third-party credit rating agencies, see
> CREDIT RATING PROCESS AND CREDIT RATING AGENCIES
RESEARCH PATH: Finance > Fundamentals of Financing Transactions > Credit Facility Basics > Practice Notes
For factors to consider when working with a clean energy company, see
> CLEAN AND RENEWABLE ENERGY INDUSTRY GUIDE FOR CAPITAL MARKETS
RESEARCH PATH: Capital Markets & Corporate Governance > Capital Markets by Industry > Practice Notes
1. The first known sustainability linked loan was completed by Royal Philips in April 2017 and sold in Europe.