New guidance to support the development of green, social, and sustainability-linked loans

The Asia Pacific Loan Market Association (APLMA), the Loan Market Association (LMA) and Loan Syndication and Trading Association (LSTA) have jointly published two new guidance documents. The first of these documents provides best practice guidance for external reviewers in the sustainable finance market. The second guidance document provides greater clarity on the requirements of the social loan principles (SLP) which were published in April 2021.

Minor updates to the Sustainability-Linked Loan Principles (SLLP) and Guidance on SLLP to reflect cosmetic and conforming changes were also published.

We have provided a high-level summary of the new guidance below together with some thoughts.

Guidance for green, social, and sustainability-linked loans external reviews

  • External reviews are an important aspect of Green Loans, Social Loans and Sustainability-Linked Loans (SLL) as they provide independence rather than relying solely on information or certification provided by the borrower. Though not a compulsory component of Green Loans or Social Loans, the SLLP require verification by an external reviewer as one of the five core components of a SLL.
  • The new guidance is based on the International Capital Markets Association’s 2021 Guidelines for Green, Social, Sustainability and Sustainability-Linked Bonds External Reviews and is designed to ensure, as much as possible, consistency across loan and bond markets.
  • The new guidance summarises the four types of external reviews being:
    • second party opinion: an opinion from an independent institution with sustainability expertise
    • verification: an independent verification against a designated set of use of proceeds criteria and impact metrics relating to environmental/social projects for sustainable lending
    • certification: a certification of the green, social or sustainability linked loan against a recognised external sustainability standard, for example the Climate Bonds Standard and Certification Scheme
    • loan-scoring/rating: third parties assess the green, social or sustainability-linked loan according to their established scoring or rating methodology
  • Given that different types of entities can conduct external reviews (some of which are governed by professional standards which already address many if not all aims of the guidance), the guidance is voluntary and provides that all firms providing external reviews should be guided by the following fundamental and ethical principles:
    • integrity
    • objectivity
    • professional competence and due care
    • confidentiality
    • professional behaviour
  • Borrowers should make the external review publicly available (subject to any confidentiality/competitive concerns).

Guidance on social loans principles

  • This guidance is similar to previous guidance issued on the SLLP and the Green Loan Principles and should be read together with the SLP.
  • Social washing must be avoided to preserve the integrity of the product. Similar to greenwashing. this is where misleading or inflated claims are made about the social features of the projects to be funded by a social loan. This is particularly important as social loans become more prevalent.
  • Although there is still no consensus on what constitutes ‘social’ in the context of social loans, there are a number of useful standards such as the World Bank’s Environmental and Social Standards and the United Nation’s Sustainable Development Goals.
  • A social loan can be made to a borrower that has low ESG ratings because the focus of social loans is on the eligible projects rather than on the borrower itself. In saying that, the SLP recommend that the borrowers clearly communicate to lenders their sustainability objectives overall and we do see this as a potential risk area so borrowers and lenders should be openly discussing how the Social Loan fits into their overall ESG strategy.
  • Given the increasing ESG disclosure requirements on financial institutions, lenders should consider including an express consent from the borrowers to disclose the details of any social/ESG transaction for reporting and disclosure purposes.
  • While there is no established market standard in relation to what will constitute a social breach, any breach of the use of proceeds provision should be taken seriously and the loan should not be considered social from the date of the breach, subject to any cure rights.
  • Parties should consider whether a failure to apply the proceeds of a social loan towards a social project will trigger an event of default, and a subsequent cross-default across outstanding loans.
  • There is currently no template wording available but the guidance summaries key considerations for drafting social loans including a “no communication” provision where the borrower should cease to refer to the facility as a social loan in any future communications in the event of a breach.

Our view

As the sustainable lending market continues to rapidly grow and financial institutions are subject to increasing ESG disclosure requirements, this guidance is timely to promote best industry practice and boost investor confidence in these products. We think the market will welcome the additional guidance on external reviewers, and our observation is that the external reviewers we commonly see in New Zealand are generally already aligned to the new guidance on external reviews and will appreciate the effort to drive consistency across the market.

If you have any questions in relation to the new guidance, please contact one of our experts.

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