Other Author Vivien Lee, Legal Assistant
On 23 February 2023, the Asia Pacific Loan Market Association, Loan Market Association and Loan Syndications and Trading Association jointly published updates on the Green, Social and Sustainability-Linked Loan Principles (the “Principles”) together with their supporting guidance documents (the “Guidance”).
All transactions completed prior to 9 March 2023 will be exempted from following the updated Principles and Guidance, and instead should be reviewed in conjunction with the Principles and Guidance in force at the time of the loan’s origination, extension or refinancing, as applicable.
All green, social and sustainability-linked loans originated, extended or refinanced after 9 March 2023 must fully align with the updated Principles and Guidance to be classified as green, sustainability-linked or social loans.
Key Updates to the Green Loan Principles (GLP) and the Guidance on Green Loan Principles (GLP Guidance Note), and Social Loan Principles (SLP) and the Guidance on Social Loan Principles (SLP Guidance Note)
1. Approval of Cross-labelling
The updated GLP Guidance Note and SLP Guidance Note clarify that a loan can be a combination of green loan (GL), social loan (SL), and/or sustainability-linked loan (SLL). The classification of a loan as either a GL or SL or both would ultimately be based on the primary objectives of the underlying project. If a loan satisfies all core components of both the GLP and SLP, the borrower has the option of referring to it as a GL and/or SL. If a green or social loan is also to be classified as a SLL, the borrower must specify certain key performance indicators (KPIs) and sustainability performance targets (SPTs).
2. Broader Considerations to Be Taken into Account in the Process for Project Evaluation and Selection
In addition to the environmental sustainability or social objective(s) of the project (and in the case of social loan, the target population of the social project), the updated GLP and SLP require the borrower to communicate to the lenders the complementary information on the processes by which the borrower identifies and manages perceived, actual or potential environmental and social risks associated with the relevant project(s).
A more nuanced approach should be taken by borrowers to have a process in place to identify mitigants to known or potential material risks of negative social and/or environmental impacts from the relevant projects, which may include clear and relevant trade-off analysis undertaken, and monitoring where the potential risks are meaningful.
3. Tighter Requirements for Management of Proceeds
The updated GLP and SLP stipulate that management of proceeds should be attested to by the borrower in a formal internal process linked to the borrower’s lending and investment operations for green or social projects. The borrower should also make known to the lenders any intended types of temporary placement for the balance of unallocated proceeds, and ensure that selection of such temporary investments does not damage the integrity of the green or social loan market.
It is also clarified that, a facility cannot be labelled as green or social if it includes a green or social tranche and non-green or non-social tranche(s) – the green or social label should only apply to the tranche(s) aligned to the four core components of GLP or SLP.
4. Suggested Harmonised Methodology for Reporting on the Impact of Loan Proceeds
It is recognised in the updated GLP Guidance Note and SLP Guidance Note that transparency is of particular value in communicating the expected and/or achieved impact of green or social projects – including through the use of qualitative performance indicators, and where feasible, quantitative performance measures.
The updated GLP Guidance Note and SLP Guidance Note suggest that loan participants may make reference to the Harmonised Framework for Impact Reporting (June 2022) published by the International Capital Market Association in relation to the bond market, which encourages harmonised impact reporting by providing core principles for reporting the impact of projects, together with suggested metrics and provision of templates to cover most eligible projects.
5. Additional Detail on External Reviews
The updated GLP and SLP recommend that, where appropriate, borrowers should appoint external review provider(s) to assess, through pre-origination external review, the alignment of their green or social loan with the four components of the GLP or SLP (i.e. Use of Proceeds, Process for Project Evaluation and Selection, Management of Proceeds and Reporting).
Post-origination, it is recommended in the updated GLP Guidance Note and SLP Guidance Note that a borrower’s management of proceeds be supplemented by the use of an external auditor, or other third party, to verify the internal tracking and allocation of funds from the green or social loan proceeds.
6. Clarification on Refinancing of Green or Social Loans
Green or social loans are often used to refinance assets that have a longer operating lifetime than a loan’s tenor. Eligible projects would qualify for refinancing as long as they are in use, follow the relevant eligibility criteria at the time of refinancing, and still assessed as making a meaningful impact. The updated GLP Guidance Note and SLP Guidance Note recommend that borrowers clarify which projects are to be refinanced and disclose, to the extent relevant, the expected look-back period (i.e. the number of previous years that the borrower will look back to) for these refinanced projects.
It is also clarified that long-dated green or social assets, including their maintenance and/or upgrade costs, may be (re)financed by multiple green or social loans subject to key disclosures by the borrower. The easiest way to do so may be using a portfolio-based management of proceeds approach, where multiple green or social loans finance one single pool of assets and expenditures. The borrower should also explicitly state the age and remaining useful life of the asset, any (re)financed amounts, the (re)evaluation of continuing environmental benefits of all eligible projects/assets and, as appropriate, that of an external reviewer.
7. Clarification on Whether Borrowers at the Start of Their Transition Journey – or Have Low ESG Ratings, Exposure to Controversial Issues or Controversial Sectors/Technologies – Can Borrow Green or Social Loans
The updated GLP Guidance Note and SLP Guidance Note clarify that the focus of green or social loans is on eligible projects, rather than the borrower itself. That said, the GLP or SLP require borrowers to clearly communicate to lenders their environmental and/or sustainability objectives overall, which may be taken into consideration by lenders.
Hence, for borrowers at the start of their transition journey or in the presence of controversial ESG issues, lenders may require additional transparency and disclosures from the borrower.
8. Clarification on Whether Carbon Offsetting is Envisaged within the GLP List of Eligible Projects
It is clarified in the updated GLP Guidance Note that carbon offsetting is not envisaged within the GLP list of eligible projects.
Key Updates to Sustainability-Linked Loan Principles (SLLP) and Guidance to SLLP (SLLP Guidance Note)
1. Clarification of Purpose and Classification of SLL
The SLLP emphasises that the purpose of a SLL is to incentivise a borrower to achieve material, ambitious, pre-determined, regularly monitored and externally verified sustainability objectives through KPIs and SPTs.
The SLLP Guidance Note makes a number of key clarifications on SLLs and the SLLP. In particular, it specifies that:
- the SLLP do not prescribe a minimum level of ESG performance or consider any exclusions as long as all of the core components of the SLLP are met. In fact, SLLs are intended to be accessible to all borrowers, regardless of their sector, geography or level of suitability, provided they deliver alignment with each of the core components of the SLLP.
- the SLLP are designed to support a borrower in its transition journey, wherever they might be on that journey.
Furthermore, the SLLP Guidance Note makes it clear that loans with certain sustainability elements, but cannot comply with all components of the SLLP, can no longer be represented as SLLs. Only after both KPIs and SPTs are agreed and set, and all other core components of the SLLP are met, can a loan be communicated as a SLL. Where there is a time crunch and a borrower has a clear sustainability strategy in place, parties may agree to include the mechanism of a SLL within the documentation, with these mechanisms to be switched on when SPTs are agreed post origination. This should take place no later than 12 months post origination.
2. Selection of “Material” KPIs
The SLLP Guidance Note discusses the meaning of a “material” KPI. It identifies the multi-faceted nature of “materiality” which can be understood from different vantage points:
- from an economic standpoint: ESG issues captured by the KPIs should be those with the greatest impact on the activity, strategy orientation, and the operational and potential financial performance of the borrower.
- from the sustainability standpoint: ESG issues captured by the KPIs should have the highest impact on the environment and/or society, whether to external stakeholders or internally.
In practice, a borrower should seek to benchmark its KPIs by undertaking a materiality assessment of itself and its industry. These assessments would identify the most important ESG considerations for the purpose of selecting appropriate KPIs for a SLL. These assessments will reduce the likelihood of borrowers from presenting a proliferation of KPIs that are not credible.
3. Setting Ambitious SPTs
SPTs must be ambitious, and intended to show improvement beyond the “business as usual” trajectory. In this connection, the SLLP Guidance Note sets out some basis upon which borrowers can ensure, and lenders can assess, whether the SPTs are ambitious and suitably meaningful to the borrower’s business:
- borrowers should use industry initiatives and standards to ensure the SPTs are ambitious.
- SPTs should not be set lower than the historical performance achieved by the borrower without plausible explanation.
- SPTs should go beyond regulatory requirements applicable from time to time.
- SPTs should be set based on a combination of benchmarking approaches, such as historical and externally verified values, and those selected by the borrower’s peers, industry or sector standards.
The SLLP Guidance Note offers further details on verification, in particular on post-signing verification.
For pre-signing verification, the recommendation remains that a borrower should seek an external opinion or KPI/SPT assessment to, amongst other things, confirm the alignment of their SLL with the core components of SLLP.
As for post-signing verification, this is aimed firstly at seeking independent verification of a borrower’s performance against its SPTs; and secondly at addressing material changes to parameters/KPI methodology/SPT(s) calibration. Borrowers are encouraged to ask external reviewers to assess any of these changes.
The SLLP Guidance Note also recommends that verification of KPIs should occur at least once a year, as well as any date or period relevant for assessing SPT performance that may lead to an adjustment of the loan characteristics.
Similar to GLP and SLP, the reporting section of the SLLP has been updated to highlight the necessity of transparency between lenders and borrowers. The update specifies that a borrower should supply to the lenders annually a sustainability confirmation statement, including verification report, outlining the borrower’s performance against the SPTs for the relevant year and relevant impact, and timing of such impact, on the loan’s economic characteristics. Regular monitoring of the borrower’s commitment in achieving its sustainability goals is essential for lenders to predict their economic returns.
5. Documentation Aide
SLL Guidance Note also sets out the best practices in documentation. For instance, it references the Term Sheet (with Sustainability-Linked Loan Appendix) published by APLMA in September 2022.
The updates to the Principles and Guidance undoubtedly set the bar for green, social and sustainability-linked loans and elucidate the importance of transparency between borrowers and lenders.
Lenders participating in these investment products now have a more elaborate baseline in understanding and monitoring the green, social and/or sustainability-linked goals and objectives of borrowers.
Green, social and sustainability-linked loans are constantly evolving, and the GLP, SLP and SLLP will be reviewed on a regular basis to accommodate the development and growth in these products.