Sustainability linked loans (SLLs) have become a feature of the Irish loan market in the last few years. Lenders and borrowers alike are being driven by regulatory requirements and new reporting obligations. An example of which is the Corporate Sustainability Reporting Directive (CSRD) that will come into effect for large publicly listed companies from January 2024. Many lenders and some borrowers have also set their own sustainability targets aiming to appeal to their stakeholders including investors, shareholders and consumers. Given this, in May 2023 the Loan Market Association (LMA) published provisions (Draft Provisions) for SLLs. See our previous article where we outlined what the LMA provisions for SLLs mean for borrowers and lenders. In this article, we review examples of SLL provisions that we encounter regularly in the Irish market.
Agree to agree
In the Irish market we have most frequently seen clauses requiring the borrower and the lender to enter into negotiations for a set period. The purpose of these negotiations is to agree key performance indicators (KPIs) and sustainability performance targets (SPTs) to measure the borrower’s compliance. The goal is to agree KPIs and SPTs that are relevant to the borrower’s business and sustainability strategies. Once they are agreed, they can be incorporated into the loan agreement through an amendment agreement. More commonly such clauses compel the parties to agree KPIs and SPTs by a specified date. However, we have also experienced clauses that only oblige the parties to enter negotiations with no penalty where KPIs or SPTs are not agreed.
The "agree to agree" language can be attractive to both sides, for example, if there is:
- A need to enter the loan agreement within a tight deadline, or
- A lack of precedent KPIs and SPTs in the sector the borrower operates within
The "agree to agree" language also gives the borrower time to consider KPIs that are relevant and material to their business and for the lender to consider if the KPIs are measurable or quantifiable.
Whilst the “agree to agree” clause is still most prevalent, we are observing an increase in lenders and borrowers agreeing KPIs and SPTs within the initial loan agreement. Typically, they will be listed in a separate document that is included as a schedule. The most common SPTs relate to reductions in the borrower’s greenhouse gas emissions, but we are aware of SPTs relating to:
- Reducing food waste
- Onsite generation of energy, and
- Rainwater harvesting
To ensure borrower compliance, we are seeing the inclusion of information undertakings which oblige the borrower to provide a compliance certificate demonstrating SPT progress.
The incentive for the borrower to meet the SPTs will usually be a margin reduction for a defined period, often 12 months. The margin reduction may be cumulative eg a reduction of 0.01% per SPT met within the relevant period up to a set limit, or a single margin reduction may be applied. Margin increases may also be applied for failure to meet SPTs, or failure to deliver compliance certificates, though they tend to be modest, and penalties will not extend to a breach of the loan agreement.
An issue for borrowers and lenders is deciding what KPIs will be relevant for the business, and also developing appropriate compliance measurements. This can be difficult in the absence of guidance or third party verification and monitoring.
Third party certification
One body providing third party verification is the Science Based Targets initiative (SBTi), who validate “science based targets” for companies to reduce their carbon emissions. Targets are developed for specific sectors and according to the size of the company, including for SMEs. We have observed lenders offering margin reductions in loan agreements subject to SBTi validated targets.
In the development finance sphere, we are also regularly experiencing lenders providing margin reductions subject to ongoing Home Performance Index (HPI) certification. This is an accreditation provided by the Irish Green Building Council involving five separate criteria:
- Health and wellbeing
- Quality assurance, and
- Sustainable location
Home Building Finance Ireland (HBFI) have introduced a “green loan” product for developers providing a margin reduction of up to 0.5% for developments that have been certified with HPI. Other lenders are also providing margin reductions when ongoing HPI certification can be demonstrated.
Third party verification such as SBTi or HPI provides obvious benefits for the lender by removing the need to agree KPIs and SPTs. In addition, it removes the need for monitoring of ongoing compliance by the borrower.
The use of SLLs will continue to grow in the coming years as a consequence of increasing lender, borrower and/or sponsor/investor demands. It is likely that most syndicated loan agreements and many bilateral agreements will contain some form of SLL provision. Margin adjustments have generally been modest, and this is especially true for any increases in margin for failure to meet SPTs. It will be interesting to see if HBFI’s 0.5% margin reduction is applied by other lenders and in spheres outside development finance. There also appears to be scope in the market for third party verification bodies and services. Independent verification reduces some of the burden on lenders and borrowers to negotiate and ensure compliance, and so this space is also likely to grow.
The content of this article is provided for information purposes only and does not constitute legal or other advice.