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Coronavirus - Sustainability-Linked Loans: Where have they come from and where are they going in a post covid-19 world? - UK

  • United Kingdom
  • Banking and finance
  • Coronavirus - Country overview
  • Financial services and markets regulation - ESG


Evolution of Sustainability-Linked Loans

Sustainability-Linked Loans (SLLs), also known as ESG (environmental, social and governance) loans, are general corporate purpose loans which have an additional intention of facilitating and supporting environmental and/or socially sustainable economic activity and growth. SLLs are non-sector specific, so can apply to any corporate, regardless of underlying asset class.

Whilst SLLs are a relatively new concept, they have evolved from a package of different principles including the Equator Principles, the Green Bond Principles, the Green Loan Principles and the Sustainability Bond Guidelines, as well as a host of EU regulations. The Sustainability-Linked Loan Principles (SLLP) (published in March 2019 by the Loan Market Association, the Asia Pacific Loan Market Association and the Loan Syndications and Trading Association) aim to promote the development and preserve the integrity of the sustainability-linked loan product by providing guidelines which capture the fundamental characteristics of these loans.

SLLs have traditionally supported environmental and socially-sustainable economic activity.  In the current period, there are likely to be a range of new opportunities to integrate enhancements or step-changes in healthcare or which otherwise help to address the humanitarian consequences of COVID-19. Healthcare is multifaceted and covers prevention and vaccination of disease, the community around healthcare delivery, access to healthcare products and universal healthcare coverage.  Climate change is similarly broad and complex and spans not only renewable power but energy efficiency, storage and transitions in transport and buildings.  All of these are challenging topics in themselves, but as SLLs are intended to introduce incremental change, however modest or substantial that might be, all SLLs are thought to be an important steps in the overall energy transition agenda.

Sustainability-Linked Loans

When considering whether to enter into a SLL, there are three main determinants to be considered by both borrowers and lenders:

1. Pricing

A SLL enables lenders to incentivise the borrower to focus on their sustainability performance by rewarding improved ESG performance through beneficial pricing. This works by way of a reduction to the margin if the borrower hits predetermined targets. As the market has evolved we have seen a shift towards two-way pricing: as well as the reduction in margin for hitting targets, there can be a corresponding premium added to the margin for failing to achieve such targets. Recent guidance on the SLLPs confirmed there is indeed now an expectation of a margin premium being applied on SLLs. Interestingly, we have recently seen stepped reductions to the margin, if a borrower goes above and beyond initial targets. In each case, a key consideration will be how to accurately measure the borrower’s current operation, in order to ensure the base line is correct.

2. Targets

The borrower’s performance is measured using sustainability performance targets, which will differ on a case by case basis but should be aligned with the borrower’s overall CSR strategy. The targets should be both ambitious and meaningful and should go beyond what the borrower would have achieved in the ordinary course of business. The SLLPs set out some common categories of targets, together with an example of the improvements a borrower may choose to make. It is important to note that these are merely suggestions and therefore there is huge potential in the market to broaden the categories and produce tailored targets. We have advised on a wide range of targets, including targets relating to increased numbers of people being placed into work or work-based training programmes, through to a higher percentage of recycled materials being used in manufacturing processes.

3. Reporting

Borrowers are encouraged to provide regular, up to date information relating to their targets to lenders, at the very least once a year. The information should be publicly reported, if possible, through an annual report or CSR report. We are seeing increased scrutiny around the reporting requirements from lenders; traditionally reporting took place through an additional statement being delivered to the lenders as part of the annual reporting on financial statements. More recently, we are seeing a shift towards a requirement for reporting being undertaken by an independent third party, with a performance report from the third party verifier and a compliance certificate from the borrower being delivered to the lender before any adjustments are made. There is, however, no globally accepted methodology for reporting on sustainability performance targets.

Key discussion points

Third party verification

One of the main topics for discussion between borrowers and lenders is the requirement for third party verification. The requirement to have an external, independent verification of the targets is a matter to be negotiated and agreed between the borrower and lenders on a transaction by transaction basis. For publicly traded companies, it may be sufficient for the borrower to rely on public disclosures, however, this may not be accepted by all lenders. In order to ensure that data is being accurately recorded to determine whether the sustainability performance targets are being met we are seeing more and more lenders ask for external verification being put in place. Whether the borrower is a public or a private entity, it will require strong justification in order to self-verify its own ESG performance for the purposes of an SLL.  

Deciding to use third party verification is not the end of the discussion. Certain sustainability targets, such as increased use of recycled products or reduction in use of water, are quantifiable and can be measured fairly easily. Other targets, for example, increases in sustainable suppliers in the production chain or improvements in conservation, can be much harder to measure and involve a more thorough auditing process. A further point to consider is whether there is standardisation of ratings in relation to the anticipated target, and, if there is, whether there is consistent standardisation between the ratings providers. Additionally, ESG ratings are going to evolve over time, as we inevitably increase our sustainable standards and become more sophisticated. There will be a need to consider whether targets should be revisited during the course of the loan, if it is felt appropriate to do so.

There are a small number of companies with a long established presence in the market in providing ESG and Corporate Governance research and ratings, but long term experience in this sector is relatively slim in comparison to others. Traditional auditing firms are quickly building up presence in the market of sustainability auditing, yet may not have sufficient expertise in relation to certain specific ESG targets. What is key for lenders and borrowers alike to consider is that in order for any audit to be meaningful, the borrower needs to have the appropriate frameworks in place in their underlying contracts so that the data can be correctly collated in order for the target to be audited, reported on and it can be established whether or not the borrower has hit such target.

Use of funds

A second major discussion point is how any funds from the adjusted margin should be used. It is commonly agreed that any benefit to the borrower from a reduced margin shall be put towards an ESG project or a sustainable purpose. We do not normally see the projects or purposes being controlled within the loan agreements and, as such, are generally left to the discretion of the borrower. As two way pricing is becoming more commonplace, it is important that lenders are not seen to profit from a borrower failing to hit it’s targets through the increased margin. An interesting development in our latest SLL provided that where the borrower was to pay an premium on the margin due to failure to hit targets, the additional amount received by the lender was passed back to the borrower, to be used towards an appropriate sustainability project carried out by an entity outside of the borrower group and to be agreed with the lenders.


Finally, there is concern amongst both lending institutions and regulators alike about “green washing” - a process whereby a loan is packaged and promoted as a sustainable loan when, in reality, goes no further in supporting ESG growth than an ordinary loan. When considering whether to enter into a SLL, it is important that the SLLPs are considered in detail and sufficient importance is placed, not only on the targets set at the outset of the loan, but also on how these targets are monitored and validated.

Organisations looking to finance projects which are inherently green (such as renewable energy projects) and which may in the past have turned away from a SLL on the basis that it provides little additional ESG benefit may consider drawing on non-green SLL principles.  These might include targeting increased local employment or training. That way, the SLL properly reflects its label and any greenwashing inference is avoided.

The future of Sustainability-Linked Loans

SLLs are in their infancy and we believe that they have significant potential across the loan market.  As they can apply to any corporate, regardless of the sector, almost any borrower can benefit from receiving advantageous margins at the same time as furthering its sustainability objectives. With pressures from government, regulators and the wider market to improve sustainability and ESG, SLLs are positioned perfectly for borrowers to achieve improved sustainability performance for their stakeholders. While borrowers gain improved pricing, lenders can treat margin reductions as an implicit financial contribution to the sustainability agenda.  Take up on SLLs so far has been voluntary, however as sustainability is becoming much more mainstream and ESG is moving into the forefront of everyone’s agenda, and as there is a clear avenue in the near-term for SLL principles to be applied to financing projects which deliver enhanced or step-changes in healthcare or which otherwise address the humanitarian consequences of the pandemic, there is possibility that at some point in the not too distant future all loans will need to incorporate some form of sustainability compliance, without the beneficial pricing being offered.