What is a sustainability loan and should my business get one? | Foley Hoag LLP


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Under pressure from shareholder groups, investors and clients, you may already have “green initiatives” in your business plan, and you have probably already identified the risks associated with climate change and climate change. other social and environmental factors. Is there a way to monetize what you are already doing by accessing the growing market for sustainability-linked loans (sometimes referred to as ESG-linked loans)? We will refer to these loans here as sustainability loans or SLLs.

What is a sustainable development loan? Is it the same as a “green loan”?

A “green loan” is structured like a typical loan, the only difference being that the proceeds of a green loan must be used for specific environmental or sustainability initiatives. In contrast, a sustainability linked loan can be used for general business purposes, but offers the borrower better pricing if it meets certain sustainability performance metrics. Because there is more flexibility regarding the use of the products, these SLLs are more accessible to most companies than green loans, especially for companies that follow and already take into account environmental, social and governance criteria. (ESG). As a result, along with the increased interest of politicians and investors in green initiatives, the market for these loans is skyrocketing. Bloomberg News recently reported that in the U.S. market, $ 52 billion in sustainability-related loans were funded between January 1 and May 21 of this year, which is nearly three times as many of those loans funded in 2020. Experts expect the SLL market to grow only from here.

How are ESG metrics measured in sustainability lending, and is it costly to comply?

From a documentation perspective, sustainability-related loan agreements can be written with only small differences compared to a traditional credit agreement. The key feature of an SLL is that certain specified ESG measures reduce the borrower’s interest rate margin (in the same way that some credit agreements allow the margin to be reduced when the borrower’s leverage ratio decreases). There are also additional reporting requirements, including submitting a sustainability report to lenders on an annual basis detailing the company’s performance against selected ESG performance indicators.

When it comes to monitoring ESG measures, although there are still many independent agencies offering ESG rating services, the market leader is the Sustainability Accounting Standards Board (SASB). The Loan Syndications & Trading Association (LSTA), which is the trade organization of the loan market, has adopted the SASB measures in its list of ESG due diligence requests, which it recommends that all investors solicit as part of the any loan origination process. SASB standards are tightly tailored to a borrower’s industry, highlighting key ESG performance indicators that are reliably quantifiable and externally verifiable. SASB has created an accessible and user-friendly “materiality map” that defines key ESG performance indicators specific to a given company. Since metrics are industry specific and easily quantifiable, these are often key performance indicators that companies are already tracking for the purpose of preparing annual reports, presentations to lenders, or perhaps even reports. self-sustainability reports. Ideally, borrowers can take advantage of the data they already collect to improve the pricing of their sustainability loans.

The latest LSTA guidelines recommend that SLLs include third party input on the selection of ESG KPIs as well as third party monitoring and verification of these KPIs. While this approach potentially increases the associated costs, standardization of requirements and the use of an expert promise to increase the efficiency of loan documentation and ongoing loan administration. An added benefit for some borrowers will be that this approach aligns the lending market with the monitoring requirements of the sustainability bond market, making it easier for a business to refinance across markets.

If my business doesn’t get a sustainability loan, should we be concerned about ESG disclosure?

With SLLs becoming more common, investors increasingly expect ESG information as part of traditional credit facilities. As mentioned above, the LSTA has prepared an ESG Due Diligence Questionnaire (ESG DDQ) form that it recommends that investors require borrowers to complete and provide to the public-side data room as part of any origination due diligence process. The DDQ ESG asks the company about its ESG policies and procedures and the links to the SASB “materiality map”. Increasingly, investors see ESG risk as an important consideration in their overall credit analysis for any borrower in any industry. Borrowers can therefore expect to see ESG-related due diligence requests whether or not they are tapping into the sustainable lending market.

In addition, rating agencies are starting to take ESG risk into account in their rating process. Recently, rating agencies adjusted their ratings of several oil and gas companies based on the climate risk to the business. Credit downgrades can increase an issuer’s cost of borrowing.

Given this reality, the time may be ripe to explore access to this growing source of additional debt financing.

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