LSTA publishes revised lending principles linked to sustainability
As interest in environmental, social and governance (“ESG”) finance has grown, lenders increasingly seek to offer financial products for projects or businesses that are environmentally friendly, socially conscious. or focused on improving a company’s relationship with its community or its impact on it. . One of these financial products that has grown in popularity is the Sustainability Linked Loan (“SLL”), which includes a key pricing mechanism linked to the borrower’s sustainability operations. Based on the Borrower’s sustainability policies and goals, the Borrower and the Lender will identify key performance indicators to measure the Borrower’s progress towards sustainability goals (“KPIs”), and then set a goal of sustainability performance (“SPT”). As an example, the borrower and the lender could determine that the KPI is the reduction of greenhouse gas emissions in the borrower’s operations, while the SPT would be the specific percentage (e.g. 10%) whose emissions must be reduced over one year. on an annual basis. If the borrower meets the SPT and reduces their greenhouse gas emissions by 10% each year, they would be eligible for a price reduction under the SLL, which could result in a decrease in the margin or cost. interest rate that goes into effect once the SPT is reached. In view of the growing popularity of SLLs, the Loan Syndications and Trading Association (“LSTA”) has developed guidelines to ensure the legitimacy and credibility of the SLL financial product as a means to facilitate and support economic activity and growth. ESG compliant. Known as the Sustainability Linked Loan Principles (the “SLLPs”), these voluntary guidelines were first published in May 2019 and, together with the Guide to Sustainability Linked Loan Principles (the “Guidelines”) identify five key elements of SLL and provide a framework. to better define the recommended or required elements of an SLL. On May 27, 2021, the LSTA issued amendments to the SLLP and the guidelines stressing that the terms of an SLL should support the primary objective of promoting ESG compliant business and stressing the need for transparency and accountability. sufficient disclosure to avoid the risk or appearance of washout durability or improper use of the product. More specifically, the revised SLLP requires a third party verification of the KPIs and considerably strengthens the Lender’s ability to verify the relevance of the KPIs, the viability and ambition of the Borrower’s ESG strategy and the methodology used for the calculation of the KPIs. SPT.
1. Selection of KPIs
The SLLP has always emphasized the importance of selecting appropriate KPIs that go to an important element of the Borrower’s sustainability strategy and align with the identified challenges or objectives of the Borrower’s industry. However, the revised SLLP stresses the importance of selecting credible KPIs to ensure the integrity of the SLL financial product. In order to ensure a credible selection of KPIs, the revised SLLP adds additional parameters around the selection, including that KPIs should be able to be compared as much as possible, using an external benchmark to assess the level of ambition of the SPT. The revised guidance document notes that a KPI “can be compared” if its environmental or social impact can be compared to relevant regulatory standards or taxonomies, including targets identified in international agreements such as the Paris Agreement or other industry standards. Finally, the revised guidelines also clarify that providing a “clear definition of KPIs” involves providing an applicable scope, for example by explaining how the SPT is integral to the sustainability or ESG strategy of the borrower, by plus existing guidance needed by the scope and methodology of KPIs. be clearly identified.
2. SPT calibration
While the SLLP has always required that any SPT be ambitious and established in good faith, the reviews recommend broad disclosure and input from third parties to help verify the adequacy of the SPT. In particular, the revised SLLP states that disclosures regarding the SPT must clearly identify the following:
- Schedules for performing the SPT, including observation periods, frequency of SPT review and trigger events;
- To the extent that historical data is available, a verified baseline or scientific benchmark as to the Borrower’s progress, and a clear rationale for the choice of this baseline or benchmark;
- If applicable, a description of the situations in which recalculations or pro forma adjustments to the SPT may be appropriate; o A description of how the Borrower intends to achieve the SPT, such as a description of its ESG strategy, operational procedure, key actions to be undertaken and the expected impact of any key actions in quantitative terms, if possible (while respecting confidentiality and competitive considerations); and
- Any key factor beyond the direct control of the Borrower which may affect the ability of the Borrower to achieve the SPT.
In addition, the SLLP continues to encourage the Borrower to seek the advice of an external party when selecting the SPT, in particular by obtaining a pre-closure opinion from an external reviewer assessing the relevance, robustness and the reliability of the KPIs and benchmarks selected, the rationale and level of ambition of the proposed SPT and the credibility of the strategy proposed to achieve these objectives. In the event that a SPT is revised following the closing of a transaction, it is recommended that the Borrower re-contact the issuer of the pre-closing opinion to assess the changes, including any adjustments. the methodology, strategy or applicability of the Borrower to the industry. While the SLLP previously recommended that if no external contribution is solicited, the borrower should demonstrate or develop expertise to verify its methodology, the revised SLLP adds an additional recommendation that the borrower thoroughly document this expertise and provide the lender with the documentation demonstrating the validity of the methodologies. used.
3. Loan characteristics and reports
Few changes have been made to SLLP with respect to the major SLL components of loan characteristics and reports. Borrowers continue to be encouraged to transparently communicate up-to-date information to lenders (and the public, to the extent possible), at least annually, on the ongoing progress and continued relevance of the SPT. However, one notable change clarifies that when a Borrower reports on its progress, it is encouraged to provide details of any underlying methodology used in its calculations.
In perhaps the most significant revision, where the previous version of the SLLP only recommended that Borrowers seek independent and external verification of their performance against each SPT for each KPI, the updated SLLP requires that the Borrower obtain independent and external verification by a qualified external reviewer. with relevant expertise, such as an auditor, an environmental consultant and / or an independent rating agency, at least once a year. The revised SLLP goes on to state that while the pre-signature advice suggested in the SPT calibration remains recommended, third party verification of the SPT and associated KPIs on an ongoing basis is a necessary part of an SLL. Once the report is complete, lenders will then use the external review to independently assess the borrower’s performance against the SPT and KPIs. This change contrasts with many SLLs, which currently require the borrower to self-certify only on their progress and completion of the SPT, without any independent verification or requirement to provide underlying data or calculations.
Finally, the annex to the SLLP was amended to provide common categories of key performance indicators relating to both “social” and “governance” issues – an extension of the annex from the previous version which only listed the “environmental” categories. Examples of social improvements that a KPI might seek to measure include human rights and community relations, affordable housing, data security, employee health and safety, employee engagement, diversity and inclusion, and employee training. Examples of governance improvements that a KPI might seek to measure include business ethics and the establishment of strong governance and transparency.
The updated SLLP will come into effect for all transactions made on or after June 3, 2021.