COMMENT | Are sustainability loans right for you?

It’s a hot topic and seems to be tripping off everyone’s tongues: sustainability-linked loans and green loans, writes Eleanor James of Trowers & Hamlins. But what are they, are they applicable to you, and why get one?

Sustainability-linked loans

The first thing to say is a sustainability-linked loan (SLL) is different to a green loan (GL), and therefore has different benefits and expectations as a result.

Sustainability-linked loans aim to facilitate and support environmentally and socially sustainable economic activity and growth. They are usually structured to incentivise a borrower to achieve predetermined sustainability performance objectives, ie reduction of internal greenhouse gas emissions or improvements to energy efficiency.

Ideally, these objectives will be ambitious and involve the organisation stretching to achieve them. The incentive to achieve these sustainability targets will usually be a ratchet on the interest rate. This could be one-way – hitting targets results in a margin reduction benefitting the borrower – or may swing in both directions to encourage performance. In either case the margin reductions or increases typically reset to a baseline every year.

Unlike their cousins, the GLs, SLLs do not typically require dedication of funds to specific eligible causes. SLLs may therefore be useful if desired outcomes are more diverse and in circumstances where allocation of funds could be more difficult to track.

Green loans

GLs are defined by the Loan Market Association’s Green Loan Principles (GLP) glossary as any loan instrument made available to finance new and/or eligible green projects. Certain sections of the market are benefitting more from this type of loan structure than others. So, for example, this may involve the development of property to a higher EPC standard, or potentially help to finance retrofit projects targeted at improving the energy efficiency of existing assets.

The Loan Market Association sets core principles which require the borrower to demonstrate how a green project is chosen, require the keeping of readily available information regarding use of funds for a green project and transparency in fund allocation.

Decisions, decisions…

When considering whether funding of this type will be suitable for you as a borrower, it is worth considering that, broadly speaking, a GL lends itself to a term loan structure and SLL to revolving credit facilities.

The reason for this is that the nature of a revolving credit facility – ie the ability to repay and redraw – makes tracking of funds into green projects almost impossible and therefore makes the core requirements of the GLP more difficult to demonstrate.

If the borrower is looking for a “reward” for delivering environmentally beneficial outcomes an SLL may be the best bet. However, with ratchets for attainment of objectives relatively small, many borrowers are now seeking alignment with global green principles from an altruistic standpoint rather than purely a capitalist one.

It is also worth considering that there is some overlap between the two categories of loan. An SLL may allow the selected performance targets to be set in a slightly wider context, for example incorporating more socially focussed elements, rather than delivering purely ‘green’ benefits.

Final thoughts

There is definitely a shift towards making borrowers accountable for their own sustainable activities. On the investor side an increasing focus on ‘ESG’ (Environmental, Social and Governance), ‘impact’ or ‘sustainable’ investing has been developing for some years driven by market forces and regulatory bodies. As regulators and consumers alike seek further transparency and see the inherent value of sustainable investments, GLs and SLLs are here to stay.

• Eleanor James is partner at Trowers & Hamlins. To contact Eleanor, email ejames@trowers.com