We recently outlined the underlying factors behind the increase in sustainable lending and the key differences between the Green Loan Principles (GLPs) and Sustainability Linked Loan Principles (SLLPs), which you can read here.
The Loan Market Association, the Asia Pacific Loan Market Association and the Loan Syndications and Trading Association together also recently published the Social Loan Principles (SLPs). The SLPs provide further guidance on the documentation of sustainable lending. This publication comes in the wake of rapid growth in social loans arising as a result of the COVID-19 pandemic.
The SLPs are voluntary recommended guidelines for social loans. Like the GLPs and SLLPs, the SLPs recommend transparency and disclosure in the documentation of sustainable loans.
The SLPs are also intended to complement the Social Bond Principles (SBP) introduced by the International Capital Markets Association, with a view to promoting consistency across financial markets. There may be occasions where the SBP and SLPs will be used together. For example, an issuer may issue social bonds using the SBP, and thereafter, when it comes to using the proceeds of the bond issue, the issuer may act as a lender and use the SLP to provide social loans to one or more ultimate borrower.
Social Loans are defined in the SLPs as “any type of loan instrument made available exclusively to finance or re-finance, in whole or in part, new and/or existing eligible Social Projects.”
“Social Projects” are projects that fall within one of the non-exhaustive categories outlined in the SLPs, including:
Employment generation and programs designed to prevent and/or alleviate unemployment stemming from socioeconomic crises, including through the potential effect of small and medium enterprise financing and microfinance
Food security and sustainable food systems
Affordable basic infrastructure
Access to essential services, such as education, healthcare, or financing and financial services, and
Socioeconomic advancement and empowerment
Affordable housing and employment generation by small and medium enterprise (SME) financing will be of particular interest to lenders and borrowers in the Irish market. There has been increasing political focus on the delivery of affordable housing. It is estimated that SMEs account for 99.8% of the total number of business enterprises in the private business economy in Ireland. SMEs also employ 1.06 million people, accounting for 68.4% of total employment in the private business economy. It is anticipated that SMEs will play a significant role in the economic recovery following the COVID-19 pandemic.
The documentation of social loans should align with the core components of the SLPs:
1. Use of proceeds
The fundamental component of a social loan is the utilisation of the proceeds for Social Projects. These projects should provide clear benefits of a social nature. A social loan may form one or more tranches and can be made by way of a term loan or revolving credit facility. The use of proceeds may be easily identifiable in the loan documentation for a term loan. However, if the loan is to be advanced by way of a revolving credit facility, the documentation may not specify in similar detail the social use/purpose of the proceeds. Accordingly the parties will need to agree how best to evidence the application of funds to an agreed social objective. This may be by way of a specified social tranche, or by the borrower reporting to the lenders on the use of revolving facilities for Social Projects.
2. Process for project evaluation and selection
The borrower should clearly communicate to its lenders the social objective, the process by which the borrower determines how the project(s) to be funded fit within the eligible Social Project categories, and related eligibility criteria. This information should demonstrate how the project interacts with the borrower’s objectives, strategy, policy and/or processes relating to sustainability. Borrowers are also encouraged to disclose any social standards or certifications referenced in project selection.
3. Management of proceeds
The proceeds of a social loan should be credited to a dedicated account or otherwise tracked by the borrower. Such loan proceeds should be managed by a formal internal process linked to the borrower’s lending and investment operations for Social Projects, so as to maintain transparency and promote the integrity of social loans. Borrowers are encouraged to establish an internal governance process through which they can track the allocation of funds towards Social Projects.
Borrowers should keep readily available up to date information on the use of social loan proceeds so that this can be provided to the lenders of such loans. This should include a list of the Social Projects to which the social loan proceeds have been allocated and a brief description of the projects, the amounts allocated and their expected impact. This information may be aggregated if appropriate (i.e. on a portfolio basis). Lenders may want to consider including requirements loan documentation for periodic updates on the application of such proceeds as part of the wider financial reporting process.
Where appropriate, an external review is recommended in order to prevent “social washing”, i.e. the social equivalent of “greenwashing”. This aligns with the importance of transparency in the SLLPs and GLPs also. This review can take place by way of consultant advice; certification of qualified auditors or independent ESG rating providers; certification by an external assessment standard; or ratings by qualified third parties such as specialised research providers or rating agencies.
Such external reviews play an important role in ensuring that the proceeds of the loans deliver real social benefits, rather than simply “ticking a box” regarding ESG requirements. As the SLPs are recommendation/principle based, and do not prescribe specific drafting, without such external review there is a risk that their application could be diluted in drafting the documentation.
The introduction of the SLPs provides further guidance in the documentation of sustainable lending. The SLPs also highlight additional types of loans that will assist lenders and borrowers to achieve their ESG targets and drive the provision of information needed to increase capital allocation to financings for social purposes. There may be opportunities in respect of affordable housing and SME lending in particular. However lenders and borrowers should ensure that appropriate third party review is incorporated into these funding models, in order to ensure that transparency is maintained and tangible social benefits are delivered.
Guidance on the documentation of social loans further supports the growing framework surrounding sustainable finance. You can read our recent article summarising this wider framework here.
For more information on the key aspects of the principles and how they may affect your operations, contact a member of our Financial Services team.
The content of this article is provided for information purposes only and does not constitute legal or other advice.