Structuring and implementing green and sustainable financing
When to start considering green finance?
The logical time to consider green finance is at the time of planning any new debt raising. This includes a refinancing, for example by seeing an opportunity to restructure a company's debt as an SLL where its existing projects demonstrate a track record of sustainable performance that can be used to benchmark and monitor sustainability targets.
Typically, the process begins by a borrower appointing one or more of the lenders as a sustainability coordinator or joint sustainability coordinators. Their role includes setting the strategy and approach for creating the green finance product. They also assist with establishing the green/social loan framework which governs the use of proceeds under the green or social loan or the key performance indicators and sustainability performance targets for an SLL using advice from a third-party sustainability consultant. During the life of the loan, the sustainability coordinator may remain involved by receiving sustainability performance reports and reviewing variations to the sustainability targets or the framework established for the loan.
Structuring the deal
Leading up to a new financing or refinancing event, borrowers can discuss their green financing options with the appointed sustainability coordinators. Depending on the nature of the business, a borrower should consider the two typical structures of green loans, social loans and SLLs below.
Whole of business
When is it most appropriate to use?
All proceeds used for sustainability purposes or supporting a business that meets a sustainability framework.
Typically used in limited recourse financing such as infrastructure projects where the entire loan proceeds are for a particular purpose which satisfies the green and/or social loan criteria.
Green loan refinancing of the Sydney Light Rail PPP
Green and social loan refinancing of the Royal Adelaide Hospital PPP
Single SLL tranche
When is it most appropriate to use?
Proceeds of a particular SLL tranche with related sustainability targets.
Where different facilities or tranches are being applied to different purposes and not all (or perhaps none) of these purposes directly relate to sustainability.
Typically used in corporate financing and property financing where the borrower or the company group commit to meeting certain sustainability targets (which only impacts the relevant SLL tranche) and/or using loan proceeds under the SLL tranche for specific sustainability-related purposes, such as corporate expenditure on green improvement within the existing budget (eg. installing energy saving heating/cooling or lighting).
As detailed below, one of the consequences for not meeting performance targets or breaching sustainability requirements is the risk of penalty pricing for the relevant SLL tranche, however this impact is limited to that tranche only.
SLL facility included in refinancing of NSW Land Registry Services corporate facilities
Refinancing of existing debt facility of Westfarmers Limited into a $400m SLL facility
Refinancing of Coles existing debt facilities
Documentation and compliance
Once the structure of the green financing is chosen, lawyers are engaged for the documentation of the green financing terms.
Green loans and social loans take the same form as other bilateral or syndicated loans but include the following additional features that allow them to be marketed with the 'green loan' or 'social loan' label:
Requirement for proceeds to be applied to green or social projects (as applicable)
Best efforts obligations to comply with a green or social loan framework
Ongoing reporting obligations on compliance and use of proceeds, usually annually
Certification of compliance with APLMA / LMA / LSTA Green Loan Principles or Social Loan Principles by an independent certifier (CP to financial close)
SLLs typically contain a dedicated section of the facility agreement containing the sustainability terms that covers the five core components provided in the SLLP and set out in the diagram below.
KPI selection – Selection of KPIs that are material to the borrower's business, are measurable and are able to be benchmarked against external references
SPT calibration – SPTs should be ‘ambitious’, represent a material improvement beyond BAU trajectories, be consistent with the borrower's overall ESG strategy
Loan characteristics – Economic outcomes are linked to whether selected predefined SPTs are met
Reporting – Reporting on performance against the SPTs at least annually
Verification – Independent, external verification of performance levels by an auditor or other assurance provider
Green loans, social loans and SLLs all typically require certification of compliance with the relevant APLMA / LMA / LSTA principles by an independent certifier as a condition precedent to financial close (first drawing).
For green and social loans this certification involves review of whether the sustainable finance framework, which describes the use of proceeds under the loan, aligns with the core components described in the GLP or SLP (i.e. that it is used exclusively to finance or refinance a new or existing Green Project or Social Project, as detailed earlier in this article).
For SLLs, this certification involves review of the key performance indicators (KPIs) chosen and sustainability performance targets (SPTs) against the SLLP. KPIs may include star ratings for energy and water usage, reduction in greenhouse gas emissions, sustainable product use in the company's supply chain, reconciliation goals and workforce diversity. Recent updates to the SLLP have also broadened the categories of KPIs that may be employed to include social KPIs such as human rights and community relations. SPTs set out the targeted performance of KPIs which must be sufficiently ambitious, to allay growing concerns of 'greenwashing' (discussed below). This may include, for example, achievement of a certain ESG rating by an independent body each year or reaching a specified percentage of gender diversity in senior management which increases annually over a number of years. In particular, we have seen SPTs which involve a compounding annual reduction of Scope 1 and Scope 2 greenhouse gas emissions over the term of the loan, and this is starting to evolve to include measurement and reduction of Scope 3 greenhouse gas emissions given the focus of corporates on broadening their ESG commitments in this area.
Achievement of (or failure to achieve) these SPTs is linked to a margin adjustment. The SLLs may attach a reduction of, for illustration purposes, 1 to 2 bps to the yearly interest rate if a certain SPT is achieved and a reciprocal pricing increase if that SPT is not achieved, up to a maximum adjustment of say +/- 5 to 10 bps per year when all of the SPTs are assessed. Alternatively, the SLL may allocate a pricing adjustment based on the number of SPTs achieved as a whole. For example if 2 SPTs are achieved there is a 2 bps price reduction, but only a 1 bp price reduction if only 1 SPT is achieved.
To calculate the applicable pricing, the borrower is required to report on their performance levels against each SPT annually. Reporting of performance and pricing calculations are verified on an ongoing basis by independent auditors or other assurance providers.
Although green and social loans generally do not have an ongoing pricing adjustment mechanism, Borrowers must report on compliance of the green or social project with the green or social finance framework established at the outset of the loan and confirm that loan proceeds are used for this purpose.
In the Australian market, the current general position is that failure to comply with a green loan framework or sustainability provisions or to provide reports under a green loan, social loan or SLL will not constitute an event of default or give rise to a right for finance parties to terminate the agreement. Instead, the consequence of breach is that the company will no longer be able to announce, disclose or market the facility as green or sustainability-linked to third parties, and for SLLs, a pricing penalty may apply. However, this matter has been the subject of negotiation in recent deals, with some lenders pushing for events of default in relation to misrepresentation to align with developments in the UK and EU markets and the pricing if a borrower 'opts out' is a matter for negotiation in the particular circumstances.
Due to the evolving nature of ESG standards and continuing developments in understanding of market practice, SLLs may also include fallback mechanisms which allow the borrower to notify and consult with lenders where there are circumstances outside their control leading to SPTs no longer being appropriate or able to be measured or reported. This would then lead to a period of negotiation where the parties seek to agree alternative SPTs or the product ceasing to be 'green'.