Sustainability-linked loans (SLLs) have gained significant traction in Canada and the U.S. in recent years. Since their market debut, the SLL market has grown to $747 billion, making it the second-largest sustainable debt asset class after green bonds1. While the key performance indicators (KPIs) and sustainability performance targets (SPTs) in these loan products are bespoke to each borrower, market practice has been developing around the criteria for the SLL product, the roles of the lenders in the development of this feature and the relevant credit documentation.
Since 2019, the Sustainability Linked Loan Principles (SLLP), developed by the Loan Syndications and Trading Association (LSTA), the Loan Market Association (LMA) and the Asia Pacific Loan Market Association (APLMA), have been providing guidance to the credit markets on the core components and criteria of the SLL product. In February 2023, both an updated SLLP and guidance document were released to the market, along with two first-of-kind reference documents to further facilitate the development of market practice:
In this article we explore certain key takeaways from these reference documents.
As stated in the SLLP, an SLL can be any loan instrument with an economic impact to the borrower based on whether it “achieves ambitious, material and quantifiable predetermined sustainability performance objectives”. These loans aim to incentivize the borrower’s sustainability achievements using economic rewards—namely, an adjustment to interest rates and/or fees.
There is no specific use of proceeds requirement for SLLs; typically, the proceeds of the loan can be used by the borrower for general corporate purposes. While not labelled as such, SLLs can be seen as a type of transition finance as the borrower transitions towards its sustainability targets.
In the development of an SLL, a member of the lender syndicate (typically the arranger or an affiliate of the arranger) takes on the role of sustainability coordinator or sustainability structuring agent (SSA) to work with the borrower to agree on applicable KPIs and SPTs and monitoring and reporting requirements. In an effort to clarify this role, engagement letters with the arranger have started to include specific language relating to the SSA, and the LSTA drafting guidance offers some standardization for the market.
Five features of the SSA role that have developed in practice are highlighted in the drafting guidance:
The drafting guidance with respect to the SLL provisions in a credit agreement includes all of the key elements required to implement an SLL feature in a typical U.S.-style credit agreement. These provisions will also work with most forms of Canadian syndicated credit agreements, which are substantially similar to U.S.-style agreements. One thing to note is that the LSTA has not included any guidance on the actual drafting or description of KPIs and SPTs. As noted above, KPIs and SPTs are bespoke to each borrower and are designed, developed and defined in relation to each borrower’s industry, challenges and sustainability plan.
Notably, the model credit agreement provisions include proposed language with respect to “sleeping” SLLs. This term has been coined to refer to conventional loan agreements that include an ability to establish the features of an SLL (such as the KPIs and SPTs) at a later date. The SLLP has a clear statement that a credit agreement that includes an intention to set the KPIs and SPTs at a time other than inception does not qualify as a SLL until the SLLP requirements have been met.
Many market observers have raised concerns with sleeping SLLs becoming common in the U.S. and European markets and the related greenwashing risk; any disclosure with respect to any SLL component in a sleeping SLL or related marketing could potentially mislead the market into thinking that an SLL facility has been established (when in fact it has not) and equally undermine the credibility of the product.
Notwithstanding that concern, there can be circumstances where there is a mismatch between the timeline in which a credit facility is needed by a borrower and the time it takes to properly establish meaningful KPIs and SPTs. Some market participants have argued that rushing into an SLL in order to meet a timing need for the financing could lead to the borrower establishing targets that are not sufficiently ambitious or developed. Put differently, if the choice is between a less meaningful or potentially greenwashing SLL now or a thoughtful SLL later, those market participants advocate for the delayed provisions.
As such, the model credit agreement has proposed language to help market participants walk this narrow line. Borrowers benefit from the proposed provision in that it gives them some flexibility to convert the facility to an SLL. The proposed provision allows the KPIs and SPTs to be established later by an amendment that only requires majority or required lender approval (rather than unanimous consent which is traditionally required for any amendment that affects the pricing of a credit facility). In an attempt to minimize the concerns about sleeping SLLs discussed above, the guideline provisions require that any amendment with respect to the sustainability adjustment must be completed within one year of the closing date. We have seen deals in the market without the one-year limitation; there is an argument that the one-year limit is arbitrary and more time may result in more thoughtful KPIs and SPTs, depending on the specific facts applicable to a borrower.
The updated SLLP and model engagement letter and credit agreement provisions represent the latest sign of the continued growth in SLLs in the U.S. and Canadian loan markets. Many stakeholders view SLLs as a key step in helping both lenders and borrowers meet their increasingly ambitious ESG goals, and we expect to see continued growth of SLLs in the year ahead.
To discuss these issues, please contact the author(s).
This publication is a general discussion of certain legal and related developments and should not be relied upon as legal advice. If you require legal advice, we would be pleased to discuss the issues in this publication with you, in the context of your particular circumstances.
For permission to republish this or any other publication, contact Janelle Weed.
© 2023 by Torys LLP.
All rights reserved.