A Guide to Sustainable Finance

This sustainable finance framework:  

• promotes market-led solutions;  
• encourages positive environmental, social and governance (ESG) outcomes; 
• facilitates the development, use, and evolution of alternative and supplementary types of flexible debt financing. 

As sustainable financing markets have grown, this framework has been given additional structure through the creation of market practices and principles that focus on incentivising and rewarding sustainable behaviours and conduct by all borrowers.

The five benefits for borrowers

The benefits of sustainable financing to borrowers include: 

1. Meeting current (or future) stakeholder requirements: including investors, shareholders, contractual counterparties and employees. 
2. Access to capital:  for “brown” borrowers certain lenders or investors may require green or sustainability loan product to lend. 
3. Reduce exposure: of business to climate-based systemic risk. 
4. Positive press / marketing: allowing borrowers to make announcements such as “we are transitioning our business to be more green / sustainable”. 
5. Financial incentive: margin benefit / penalty for meeting / failing to meet targets. 

The benefits of sustainable financing to lenders include: 

The five benefits for lenders 

The benefits of sustainable financing to lenders include: 

1. Meeting current (or future) stakeholder requirements: including investors, shareholders, contractual counterparties and employees. 
2. Retain clients: Lenders retain ability to continue to bank 'brown' clients on a 'green' or sustainable basis. 
3. Reduce exposure: of loan book to climate-based systemic risk. 
4. Positive press / marketing: for example, statements such as “$X billion of our loan book is green / sustainable” 
5. Satisfy regulators and governments: who are expanding their focus on incorporating sustainability into a lender's investment information and decision making processes. 

There is clear overlaps between the benefits to borrowers and lenders from sustainable financing, which supports one of the core principles of this form of financing that it be much closer to a 'win-win' outcome than other forms of financing.  

Sustainable financing has two distinct financing frameworks, though there are some overlaps between the characteristics of each: 

Green finance

What is green finance?

Green finance is the financing of public and private green projects or investments (including preparatory and capital costs) in: 

• environmental goods and services (such as water management or protection of biodiversity and natural landscapes); 
• the prevention, minimization and compensation of damage to the environment and to the climate (such as energy efficiency or dams). 
• the financing of public policies (including operational costs) that encourage the implementation of environmental and environmental-damage mitigation or adaptation projects and initiatives (for example feed-in-tariffs for renewable energies); and 
• components of the financial system that deal specifically with green investments, such as financial instruments for green investments and structured green investment funds, including their specific legal, economic and institutional framework conditions.  

There are several form of green financing, such as project financing or green bonds. Project financing is a vehicle for  assembling a consortium of investors, lenders and other participants to finance, on a nonrecourse or limited recourse basis, large-scale infrastructure projects. A green bond is a fixed-income debt instrument and, like any other bond, offers a financial return. However, its distinguishing feature from so-called vanilla bonds is that it is issued for the specific purpose of funding new or existing sustainable projects or other uses beneficial to the natural environment.  

A use of proceeds approach is core to green finance. For example, bonds and loans cannot be labelled ‘green’ unless the proceeds are utilised to finance a green purpose or project. 

Green Loans are aligned to the Loan Market Association's green loan principles (discussed below).  

Sustainability Linked Loans 

Sustainability linked loans can be used by borrowers for general corporate purposes, rather than exclusively towards green projects. Rather than being 'activity based', as is the case with green loans, sustainability linked loans are based on  investments that change behaviour or practices with the intended outcome that financial inventives of a project or investment, and its sustainability outcomes, are aligned.  

A central feature to sustainability linked loans are mechanisms in the loan documents for a margin discount to apply to the cost of debt for a successful project (one that provides the anticipated financial and sustainable outcomes) or a margin increase to apply to the cost of debt for an unsuccessful project.  

LMA green loan principles 

The Loan Market Association issues a set of four core principles that apply to all green loans made in English-law governed markets: 

• Use of proceeds instrument: activity based, with funds used exclusively to finance or re-finance new and / or existing “Green Projects”  that provide clear environmental benefits. 
• Process for project evaluation and selection: a borrower should communicate to its lenders how its green objectives meet the eligibility criteria for Green Projects. 
• Management of proceeds: proceeds of a green loan should be clearly designated in a specific tranche, and once drawn, specifically tracked to maintain transparency and integrity of the product. 
• Reporting: provided to lenders annually, and to include reporting on qualitative and quantitative (eg renewable energy generated) indicators. 

The LMA green loan principles strongly recommend external review of Green Loans against the LMA principles: 

• Consultants: a borrower can seek advice from recognised experts. 
• Verification: a borrower can have its green loan verified by qualified parties such as independent ESG rating providers. 
• Certification: a borrower can have its green loan certified against an external assessment standard. 
• Rating: a borrower can have its green loan rated by qualified third parties. 

The LMA principles do contemplate Borrower self-certification where it has “demonstrated or developed the internal expertise”. Such expertise should be “thoroughly documented” including policies and procedures. 

The Asia Pacific Loan Market Association, amongst others, has supported the LMA's green loan principles for green loans made in the Asia Pacific market.  

LMA sustainability linked loan principles 

The LMA has also set out four core principles that apply to all sustainability linked loans made in English-law governed markets: 

• Relationship to the borrower’s overall strategy: a borrower needs to communicate how an sustainability linked loan will incentivise the achievement of pre-determined sustainability related performance objectives consistent with its overall ESG strategy. 
• Target setting: appropriate “ambitious” and “meaningful” targets are negotiated, with loan terms aligned to a borrower’s performance against its objectives. External review of appropriateness of targets recommended as a funding condition precedent. 
• Reporting: provided to lenders annually, but also encouraged to report publicly to improve transparency. 
• Review: the need for external review is a negotiated point, but particularly recommended when a borrower’s sustainability performance is not made publicly available. 

There is no market standard drafting for sustainability linked loan provisions, but key themes are emerging and industry standards are developing.  

For lawyers drafting sustainable financing based loan documents, there are some general principles to consider and implement into the suite of financing documents: 

• Purpose vs Behaviour: remember the distinction between green loans (Purpose) and sustainability linked loans (behaviour) and structure the loan accordingly for the business and asset in question. 
• Can you use both? there is nothing to prevent a borrower and its lenders from incorporating both a green loan (for example, a Capex Facility) and a sustainability linked loan (for example, Term Loans to refinance existing debt) provided the LMA principles for both structures can be accommodated. 
• Lender reluctance: it is possible to tranche facilities so that certain tranches are green or sustainability linked for those lenders willing to participate, whilst others are not. 
• Follow the leader: it is also possible for one (or more) lenders to be appointed as a 'sustainability coordinator' to advise on the structuring of the sustainability or green provisions in the finance documents and communicating those features to the other lenders (initial or syndication). Each lender should still satisfy itself on the relevant provisions even if such a role is undertaken and a sustainability coordinator should make it clear it has no liability or duties to any other party 

When drafting a sustainable linked loan document, there are additional drafting considerations: 

• Relationship to the borrower’s overall ESG strategy: a borrower needs to communicate how an SLL will incentivise the achievement of pre-determined sustainability related performance objectives consistent with its overall ESG strategy. 
• Target setting: appropriate 'ambitious' and 'meaningful' targets are negotiated, with loan terms aligned to a borrower’s performance against its objectives. External review of appropriateness of targets recommended as a funding CP. 
• Reporting: provided to lenders annually, but also encouraged to report publicly to improve transparency 
• Review: the need for external review is a negotiated point, but particularly recommended when a borrower’s sustainability performance is not made publicly available.