“Green loans” or “Sustainable development loans” – an overview
ESG, green loans and sustainability loans – these green finance buzzwords are growing in popularity but the details are still a bit unclear. We shed some light here on these terms and offer a more differentiated view of the options available to real estate players.
The ESG (abbreviation of Environment, Social and Governance) essentially describes criteria which now play an increasingly important role in terms of funding. We often see and read information about structured finance in the form of green loans or sustainability loans. Focusing mainly on the E in ESG, the term green loan is defined by the Green Loan Principles (GLP) developed by the Loan Market Association (LMA), the Asia Pacific Loan Market Association (APLMA) and the Loan Syndications and Trading Association (LSTA). The catalog of principles is not binding, but primarily serves as a guide and can be understood as a motivation to develop possible funding and documentation standards.
Finance green projects with green loans
In accordance with GLP, a green loan can generally be described as a lending instrument that serves exclusively to finance or refinance suitable green projects and at the same time respects the following four basic principles of GLP.
The loan proceeds from a green loan are to be used for what is called a “green project”. Such an objective should be appropriately described in the documentation. Examples of eligible categories of green projects are listed in Annex 1 (Indicative categories of eligibility for green projects) of GLP. The catalog is still fairly generic, but the green project or the object of the loan must provide clear environmental benefits. These environmental benefits must also be measurable and, where applicable, be the subject of specific reporting by the borrower. If only individual tranches are to fall under the category of green loans (while others cover what may be considered “dark green” or “for brown purposes”), this should be clearly stated in the documentation.
Project evaluation and selection process
The borrower of a green loan must clearly communicate to the lender its environmental sustainability goals, the borrower’s process by which it determines how its project fits into the categories set out in Schedule 1 of the GLP and what criteria. Eligibility related are used for this purpose.
Proceeds from a green project must be credited to a dedicated account or, failing that, transparently tracked by the borrower in an appropriate manner, in order to avoid mixing with non-green products. Borrowers are encouraged to put in place an internal governance structure that verifies that funds collected are actually spent on green projects.
Borrowers should provide and maintain up-to-date and easily accessible information on the use of funds. This information should be updated regularly, for example on an annual basis.
Sustainable development loans
Sustainability Linked Loans (often also referred to as ESG Linked Loans) are based on the principles of Sustainability Linked Loans (SLLP) which, like BPL, were also developed by LMA, APLMA and LSTA. However, the concept of sustainability loans should be distinguished from the concept of green loans as described above.
Link to general sustainability objectives
Sustainability-linked loans are loans that are characterized by the fact that the margin is linked to predetermined sustainability performance objectives (SPT) on the part of the borrower and not to the asset or object of the loan. funding. The SLLP catalog includes the following:
Selection and calibration of KPIs and calibration of SPTs
Since sustainability-linked loans are intended to improve the sustainability profile of the borrower, the loan terms should be aligned with the performance of the borrower, which is measured against one or more key performance indicators. (KPI). These KPIs should be pre-selected and should be relevant, essential and material to the overall business of the borrower, of great strategic importance to the borrower’s operations, measurable and measurable. The borrower will then have to determine the objectives on which he is ready to commit, thus calibrating the SPTs against the KPIs.
Loan characteristics and margin ratchet
These goals or SPTs can then be used as a baseline for any margin adjustment (also called a margin ratchet). If the SPT review reveals a positive spread, it has a positive impact on the lender’s margin. The margin is then reduced according to a predefined key. However, a negative evolution of the SPT can also affect the margin if it is agreed in advance between the parties. Other elements of SLPs include a requirement for regular borrower reporting and independent and external verification of the borrower’s performance level.
What are the differences between green loans and sustainability loans?
Green loans focus on the purpose of the loan or possibly the asset to be financed. The intention is to provide funding for a green asset or a green project. Sustainability-linked loans, on the other hand, refer to the borrower themselves and how they raise (or lower) their own sustainability standards.
Where are we ?
Client awareness of green loans, ESG-linked loans or sustainability-linked loans has increased, and banks and other lenders are facing pressure from stakeholders forcing them to make their loan portfolios’ more green ”. Borrowers are also starting to apply for green loans from their (potential) lenders. But what does this mean for our current practice? Is the documentation on green or sustainable loans already standard? There is no clear answer.
Market participants agree that green finance will play a predominant role in the future. The concepts presented, based on LMA publications, are valuable starting points towards common and standardized documentation. We see finance transactions with a strong emphasis on green elements, where lenders cover their needs only in their internal credit approval application process. Such loan requests then focus only on whether the asset to be financed meets certain internal green requirements. However, additional documentation (especially in financing documents) dealing specifically with green lending standards may not necessarily be agreed between the parties. In other cases, enormous progress has already been made, especially on the part of financiers, who partially demonstrate in-depth knowledge and expertise in dealing with the subject. In addition to preparing the first standard green loan documents, several financiers have already developed green loan frameworks. These green loan frameworks primarily serve as an internal set of requirements for green financing. This way, lenders can ensure that a uniform standard is followed, at least internally. Green lending frameworks are often based on the catalogs of green lending principles and sustainability lending described above. In recent times, these are further supported by the Taxonomy Regulation, which is now supplemented by delegated acts.
With regard to real estate financing, the catalog described by the taxonomy regulation and the corresponding delegated act now provides certain technical criteria for the selection of what can be considered environmentally sustainable in the building sector.
In practice, market players may encounter difficulties when verifying compliance with the criteria as this depends on the availability of the corresponding data. Therefore, data collection is something that lenders and borrowers should take into account when preparing and negotiating loan documents.
In summary, the LMA Principles and the Taxonomy Regulation give reasons and provide support to adapt and supplement loan documentations with an emphasis on green and / or ESG criteria accordingly. Market players have largely started to manage the new requirements and are starting to develop the corresponding standard documentation. However, it’s also fair to say that an overall market standard has yet to be established.