Green and Sustainability-Linked Loans Enter the Mainstream

What Is a “Green Loan”?

A green loan is a loan which meets certain environmental sustainability criteria.

The original green financing was made by way of issuing bonds. Over time, bond market participants developed criteria they called the “Green Bond Principles,” which were published in 2014. As the corresponding loan market began to develop, lenders and borrowers would refer to the bond principles to guide the structuring of green loans.

In the years following 2014, lenders developed loan specific criteria, culminating in the “Green Loan Principles” published in 2021 by the Loan Syndications & Trading Association (“LSTA”). Market participants may, but are not compelled to, consider the structures and documentation of their loans within the context of what the market considers “green.”

Green Loan Principles

Based on the LSTA definition and criteria, green loans are “any type of loan instrument made available exclusively to finance or re-finance, in whole or in part, new and/or existing eligible Green Projects.” A green loan focuses on the borrower’s use of proceeds.

Green loan instruments must:

1. Fund Green Projects. A few different types of projects qualify as “Green Projects,” for example, clean transportation, renewable energy, energy efficiency, climate change adaption, and eco-efficient products;

2. Commit to Criteria for Evaluating Green Projects. The parties must have agreed on the criteria for how a project qualifies as a listed Green Project and acknowledge any associated environmental or/social risks;

3. Address Management of Proceeds. The proceeds of a green loan must be traceable. For example, if a facility establishes multiple tranches, and only one of those tranches is considered a green loan, the proceeds of that tranche should be tracked separately from any other proceeds. Ideally, a borrower would be able to show that those specific proceeds were applied to the associated Green Project; and

4. Provide for Special Reporting. The borrower of a green loan should report to the lender on use of the loan proceeds on an annual basis. Ideally, a borrower would be able to report on the impact of a Green Project, both qualitatively and quantitatively.

What Are the Benefits of a Green Loan?

Lenders choose to provide and market green loans to applicable borrowers for a variety of reasons. Public sector pension plans are responsible for acting in the public interest and for that reason may wish to meet certain environmental, social and governance (“ESG”) standards by advancing green loans directly or indirectly through investment funds. Additionally, large fund entities may have similar objectives depending on their investors’ priorities.

Companies look to green loans because they market to customers that see value in Green Projects.

What Are the Features of Green Loan Agreements?

Green loan agreements are distinguishable in several ways, including:

1. Green Loan “Coordinator” or “Structuring Agent.” On a syndicated facility, a lender may be appointed the “Green Loan Coordinator” or “Green Loan Structuring Agent.” That lender will be tasked with a range of functions. Typically, the loan agreement will limit the coordinator’s liability in that role.

2. Green Loan Sublimit. The commitment to advance green loan amounts will often form part of the aggregate commitment.

3. Use of Proceeds. The loan agreement’s section on use of proceeds will often specifically reference the Green Project(s) that the loan funds. The borrower may need to certify how it intends to use proceeds in its borrowing request.

4. Reporting. The loan agreement may require reporting as a condition to closing and/or, on an on-going basis (for example, annually).

What Is the Difference Between a Green Loan and a “Sustainability-Linked Loan”?

Since the dawn of green bonds and green loans, a related category of financing has emerged: “sustainability-linked financing.”

Broadly, sustainability-linked financing funds businesses measuring themselves on sustainability criteria, from an “ESG” standpoint. Whereas a green loan focuses on the borrower’s use of proceeds, a sustainability-linked loan focuses on that borrower’s ESG performance. There are a few key differences between the two types of financing:

1. Use of Proceeds. The first major difference between a green loan and sustainability-linked loan relates to use of proceeds. A sustainability-linked loan could fund a green project (or business) but does not emphasize application of loan proceeds to that project. Sustainability-linked loan proceeds can be used for a business’s working capital needs.

2. Emphasis on KPI’s. The emphasis of sustainability-linked loans is on the presence of certain key performance indicators (“KPI’s”) of a business. Sustainability performance targets (“SPT’s”) may be set in respect of each KPI. Credit agreements will refer to the work of a third party “Sustainability Auditor” as well, who is selected by the parties to determine and measure the borrower’s performance sustainability metrics. Industry associations now recommend that on a syndicated facility, SPT’s and KPI’s be amended only with the consent of all lenders.

3. Applicable Margin. Often the pricing of an advance will vary for a sustainability-linked loan relative to its green loan equivalent. This pricing will typically be increased with the meeting of (or decreased, with not meeting) sustainability metrics/KPI’s, for example for the preceding 12-month period. Fees such as the commitment fee and standby fee may be reduced with the meeting of certain KPI’s as well.

4. ESG Event. Some agreements cite a material negative event such as an “ESG Event” impacting the borrower or its operations as a trigger for the borrower no longer getting the benefit of an ESG-related reduction in pricing.

What Are the Benefits of a Sustainability-Linked Loan?

As with green loan products, lenders choose to provide and market sustainability-linked loans to applicable borrowers for a variety of reasons. Both the lender and the borrower of a sustainability-linked loan stand to gain from meeting ESG standards from a reputational standpoint. Sustainability-linked loans offer the additional benefit of savings on pricing (albeit, often by a narrow margin) with meeting their KPI’s.

What Does the Future Have in Store for Green Loans and Sustainability-Linked Loans?

Green loans and sustainability-linked loans have become increasingly commonplace in Canada, and we expect that trend to continue. Once a product available only to the largest corporate institutions, lenders have begun offering these types of loans to smaller companies.

Over the past year, a number of Canadian banks have announced partnerships with Export Development Canada (“EDC”) whereby EDC will guarantee 50% of these types of loans, up to a certain maximum, for up to 7 years. These initiatives enable banks to provide more sustainable financing to support Canadian businesses. With their implementation, we expect to see green loans and sustainability-linked loans increasingly form part of mainstream financing alternatives and an increase in access for medium-sized businesses in Canada.

From a loan size perspective, of 58 sustainability-linked deals reviewed in Canada and the U.S. from 2017-2021, about half were very large ($1B-$5B), almost 30% were medium sized ($500MM-$1B), and around 17% fell within the medium to smaller range ($0-$500MM).

Of 55 sustainability-linked deals reviewed in Canada and the U.S. from 2022-2023, again more than half were very large ($1B-$5B), but only 16.36% were medium ($500MM-$1B). Almost 30% were medium to small-sized deals ($0-$500MM), representing an increase of over 10%. This suggests a move towards lenders offering more accessible, lower loan sized deals in higher volume.

One criticism of sustainability programs is that the pricing impact of meeting (or missing) sustainability-linked loan KPI’s is not material enough to effect ESG related changes in companies. We expect that companies will nevertheless treat their commitments to reach those KPI’s very seriously as they respond to increased pressure to voluntarily disclose, and be publicly accountable to, ESG targets.

At Wildeboer Dellelce LLP, we work with clients on developing bespoke approaches to green and sustainability-linked financing. We look forward to following the development of green loan and sustainability-linked loan documentation in the growing mid-market space.

If you have any questions with respect to the matters discussed above, please contact Rachel Manno by email at [email protected].

This update is intended as a summary only and should not be regarded or relied upon as advice to any specific client or regarding any specific situation.

If you would like further information regarding the issues discussed in this update or if you wish to discuss any aspect of this commentary, please feel free to contact us.