An emerging trend in debt markets is the rise of "sustainable" or "green" loans. The products are loan instruments designed to reward borrowers that focus on predetermined sustainability performance goals. Achieving or not achieving these sustainability goals will typically affect the interest payable by the borrower over the term of the credit facilities.
Bloomberg estimates that global green and sustainability linked finance volumes exceeded US$30 trillion in 2018, and the trend has also recently come to Canada. For example, Maple Leaf Foods Inc. recently closed an amendment to its credit agreement with a syndicate of lenders led by Bank of Montreal, based on sustainability principles. Under this agreement, negotiated by McCarthy Tétrault as counsel for Bank of Montreal and a syndicate of lenders, Maple Leaf Foods Inc. will benefit from a reduction of the spread on the interest payable on outstanding loans if it achieves certain agreed upon sustainability targets on "electricity use, water use, solid waste and continuing to reduce its carbon emissions in line with its achievement of net carbon neutrality".
Green Loan Principles
One basis for evaluating the efficacy of green loans are the Green Loan Principles developed by the Loan Syndications and Trading Association (LSTA), Loan Market Association (LMA) and Asia Pacific Loan Market Association (APLMA). These principles include:
- How will the funds be used? Sustainable loans are fundamentally about using funds for ecologically and development friendly purposes. Therefore, the use of the loan should be clearly described in the financial documents. All defined projects should offer clear, verifiable environmental benefits. These must be concrete, quantifiable, measured and reported by the borrower.
- How will projects be selected? The borrower and lenders should clearly agree upon the sustainability objectives; the process chosen by the borrower to determine how projects come within existing categories; and the related eligibility criteria, and if relevant, the exclusion criteria or any other process used to identify and manage potentially material environmental risks posed by the proposed projects.
- How will proceeds be managed? Governance and tracking of eligible sustainable projects is very important. The amount of the sustainable loan should be recorded in a specific account with adequate tracking to ensure transparency and promote the integrity of the product.
- What reporting requirements will be used? Accountability is key to driving performance. Borrowers should draw up information on the use of the funds that is regularly updated and made available and lenders should consider appropriate auditing procedures.
Deal Considerations
A key consideration when negotiating a sustainable loan is how to set baseline sustainability amounts of a borrower's operations. The parties may agree to select a given year as the baseline, typically the most recently completed and reported year, and then determine if a borrower has reduced or increased its carbon footprint and other key performance indicators against such baseline sustainability amounts. Care should be taken to ensure that the selected baseline sustainability amount is representative of a borrower's operations. For example, a borrower may be incentivized to seek to implement a pricing structure for a sustainability loan in a year in which their carbon footprint is abnormally high, in the hopes of generating a favourable comparison going forward.
The metrics selected for benchmarking also matter. Key performance indicators may include , among other things, total energy use, natural gas use, electricity use, water use, greenhouse gas (GHG) emissions, and solid waste produced. It is important to agree on whether the pricing adjustments will be tied to such metrics in their absolute sense (e.g. total MWh of energy used), or based on their intensity (e.g. MWh of energy per unit of output).
A further important deal consideration is the attribution of emissions. Borrowers may want to delineate between emissions from entities they directly control and joint venture partners or suppliers. In some deals the entities related to, but not directly controlled by the borrower, may have a portion of their emissions considered when assessing performance.
How the metrics will be reported also matters. For example, public company borrowers and issuers may be producing an annual sustainability report with much of the sustainability reporting and disclosure already included. Parties will need to agree on what form a report will take, the frequency and when such reporting will be delivered, and to whom. Additionally, some lenders may require that the sustainability reporting be audited by an independent nationally recognized accounting firm.
Conclusion
Sustainable loans are a rapidly growing area of debt markets. However, in order to maximize the benefit of this trend, organizations need to do their homework and understand key deal terms.
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