By Mark Norris, Partner and Theodora Okocha, Trainee
Environmental, Social and Governance (ESG) is currently at the forefront of discussions around trade and export finance, yet its application in this field is still unclear. At a time where a lot of money is moving from traditional financing into sustainable financing, market participants want to know how ESG can be implemented (and documented) into their transactions in a meaningful way.
In this blog post, we consider some of the key ways in which ESG has impacted trade and export finance, including Green and Social Loans, Sustainability Linked Loans and the push to create market standard drafting to address ESG principles.
Growth in ESG Lending
There has been significant growth in ESG lending in recent years, with Bloomberg LP reporting the increased issuance of ESG bonds and loans from $26.6 billion in 2013 to $732.1 billion in 2020. Notably, the growth of Sustainability Linked Loans has surpassed the growth of Green Loans (both described below) in recent years.
The UK government is providing significant support for sustainable projects, with the UK’s export credit agency (UKEF) contributing £2.4 billion to sustainable projects in 2020 and a further £2 billion earmarked by the UK government to support the UKEF clean growth direct lending facility for “clean growth” and “green” projects.
ESG Categories and the Matrix of Principles
A raft of ESG categories have emerged in recent years including Green Projects, Social Projects, Green Loans, Sustainability Linked Loans, Blue Loans, Social Loans, Hybrid Sustainability Linked/Green/Blue/Social Loans, Light Green Loans and Brown Projects.
Against this backdrop, a number of principles have been developed to provide guidelines for ESG financings. These include the Green Loan Principles (GLPs), the Social Loan Principles (SLPs), the Sustainability Linked Loan Principles (SLLPs), the UN Sustainable Blue Economy Finance Principles, the Equator Principles and the IFC’s Environmental and Social Performance Standards. The various loan principles seek to ensure consistency across the ESG loan market.
What are Green Loans and Social Loans?
Green Loans are made available exclusively to finance or re-finance, in whole or in part, new and/or existing eligible Green Projects. Similarly, Social Loans are available exclusively to finance or re-finance Social Projects. Green Projects address areas of environmental concern such as climate change and air, water and soil pollution. Social Projects address social issues such as affordable housing and access to essential services.
To qualify as a Green or Social Loan, the loan must meet the requirements of the GLPs or SLPs, respectively. Each set of principles has the following four core components that must be satisfied:
- Use of Proceeds;
- Process for Project Evaluation and Selection;
- Management of Proceeds;
- Reporting.
The key feature of both Green Loans and Social Loans is the use of proceeds – these must be used for a Green or Social Project. The process for project evaluation and selection requires clear communication to the lenders on how the proposed project is to fit within the eligible Green or Social Project. The proceeds of the loan must be clearly separated from any other financing through a separate account. Segregation of funds is key and should be monitored through an internal governance process so the money can be clearly tracked and reported. Lenders will also expect detailed qualitative and quantitative disclosure from borrowers. This should include performance indicators and measures and the disclosure of underlying methodology and assumptions used.
Just because a Green or Social Project is being financed does not in and of itself make the underlying loan a Green or Social Loan, unless each of the GLPs or SLPs, as appropriate, is met.
What are sustainability linked loans?
In contrast to Green and Social Loans, Sustainability Linked Loans (SLLs) provide greater flexibility for borrowers by focusing on predetermined Sustainability Performance Targets (SPTs), rather than the use of proceeds. This allows the proceeds of such loans to be used for general corporate purposes.
The SLLPs set out five core components which must be met for a loan to be categorised as an SLL. These are:
- Selection of Key Performance Indicators (KPIs);
- Calibration of SPTs;
- Loan Characteristics;
- Reporting;
- Verification.
A borrower must be clear about how its chosen SPTs fit within its overall sustainability strategy and must communicate this to the lenders. The KPIs are what is expected of the borrower in order to achieve its sustainability goals. The KPIs also measure the SPTs, which can be set to align with the UN’s Sustainable Development Goals.
It is a requirement of the SLLPs that the SPTs set by the borrower and lender must be ambitious, meaningful and measurable, seeking to achieve ambitious positive change through incentives. SLLs align loan terms to the borrower’s performance against pre-determined SPTs, negotiated and agreed between the borrower and the lenders on a transaction by transaction basis. Often, the margin under the relevant loan agreement is reduced where the borrower satisfies the SPT threshold.
The reporting of information relating to SPTs is key. Borrowers are encouraged to publicly report this information in their annual and CSR reports.
Lastly, independent external verification of the borrower’s performance against each SPT for every KPI should be obtained with the results made publicly available if possible.
Drafting – The Chancery Lane Project
There is currently no “market standard” LMA wording for ESG or sustainable loans. In practice, parties are developing their own wording which raises the question of where to start.
The Chancery Lane Project (TCLP) is a pro bono initiative that facilitates the collaboration of legal professionals in rewriting contracts. It aims to provide the documentation to support communities and businesses in addressing climate change and achieving net zero carbon emissions. The TCLP has published 71 clauses that are freely and globally available to law firms, corporations and government, e.g.:
- Guide and checklist for issuance of SLLs;
- Cooler-plate clauses (climate aligned boilerplate);
- Choice of green governing law clause;
- Green supply agreement;
- Supply chain emissions scorecard;
- Green loan starter pack.
What’s next? The “EU Taxonomy Regulation”
Recently, the EU Taxonomy Regulation ((EU) 2020/852) was put in place to meet the EU’s climate and energy targets for 2030 and to reach the objectives of the European Green Deal. It aims to define clear criteria for identifying environmentally sustainable economic activities.
For further information on ESG in trade and export finance, please contact Sullivan partner Mark Norris or your usual contact at the firm. Mark recently examined the place of ESG in trade and export finance, considering the above topics and more at the Trade and Export Finance Webinar.
