This guide provides a brief overview of the key eligibility criteria for SMEs to access sustainability-linked loans. Sustainability-linked loans represent a pivotal evolution in finance, aligning the borrowing terms with the borrower's sustainability performance.
What is a Sustainability-Linked Loan?
A sustainability-linked loan is a type of loan that incorporates sustainability performance targets into its terms and conditions. Unlike traditional loans that are solely based on financial metrics, sustainability-linked loans align the cost of borrowing with the borrower's sustainability achievements. In these loans, the interest rate or terms of the loan may be linked to the borrower's performance on predetermined sustainability goals. This innovative financial instrument incentivizes and rewards businesses for improving their sustainability practices, fostering a positive impact on the environment and society.
Loan Market Association Definition: "SLLs are any types of loan instruments and/or contingent facilities (such as bonding lines, guarantee lines or letters of credit) for which the economic characteristics can vary depending on whether the borrower achieves ambitious, material and quantifiable predetermined sustainability performance objectives”.
Example
A sustainable fashion brand securing a sustainability-linked loan in the textile and garment industry must meet outlined targets like sourcing organic materials and reducing water usage. Meeting these goals triggers a reduction in the interest rate or improved conditions, motivating the brand to pursue its sustainability commitments. This approach not only supports environmentally friendly practices but also demonstrates the brand's dedication to sustainability.
Sustainability-Linked Loan: Core Principles
Many Financial Institutions have aligned their green lending proposition with the Loan Market Association's (LMA) Sustainability-Linked Loan Principles. The LMA's Sustainability-Linked Loan Principles are a set of voluntary guidelines that aim to facilitate and support environmentally sustainable economic activity.
In addition to meeting all applicable national and international laws and regulations, the GLP is designed to provide a framework for all market participants to understand the characteristics of sustainable lending.
They are based around the following five components:
- Selection of KPIs
- The KPIs must be:
- relevant, core and material to the borrower’s overall business, and of high strategic significance to the borrower’s current and/ or future operations;
- measurable or quantifiable on a consistent methodological basis; and
- able to be benchmarked (i.e. as much as possible using an external reference or definitions to facilitate the assessment of the SPT’s level of ambition).
- The KPIs must be:
- Calibration of SPTs
- The SPTs must be set in good faith and remain relevant (so long as they apply) and ambitious throughout the life of the loan. It is therefore recommended that an annual SPT should be set per KPI for each year of the loan term.
- The SPTs should be ambitious, and take into consideration a list of factors, which you can find in the GLP document below.
- Loan Characteristics
- A key characteristic of a SLL is that an economic outcome is linked to whether the selected predefined SPT(s) are met.
- Reporting
- Borrowers should, at least once per annum, provide the lenders participating in the loan with:
- up-to-date information sufficient to allow them to monitor the performance of the SPTs and to determine that the SPTs remain ambitious and relevant to the borrower’s business; and
- a sustainability confirmation statement with verification report attached, outlining the performance against the SPTs for the relevant year and the related impact, and timing of such impact, on the loan’s economic characteristics.
- Borrowers should, at least once per annum, provide the lenders participating in the loan with:
- Verification
- Borrowers must obtain independent and external verification of the borrower’s performance level against each SPT for each KPI for any date/period relevant for assessing the SPT performance leading to a potential adjustment of the SLL economic characteristics, until after the last SPT trigger event of the loan has been reached.
SLL borrower should clearly communicate to its lenders its rationale for the selection of its KPI(s) (i.e. relevance, materiality, whether it is core to the borrower’s overall business) and the motivation for the SPT(s) (i.e. ambition level, benchmarking approach and how the borrower intends to reach such SPTs).
Borrowers are encouraged to position this information within the context of their overarching objectives, sustainability strategy, policy, sustainability commitments and/or processes relating to sustainability. Borrowers are also encouraged to inform lenders of any sustainability standards or certifications to which they are seeking to conform.
Tese’s Tips
- Understand Loan Terms and Sustainability Criteria: Gain a thorough understanding of the sustainability performance targets linked to the specific loan, ensuring a clear alignment with the business’s sustainability objectives and strategy. Make sure to cross-reference your goals with the loan requirements.
- Establish Robust Metrics and Reporting Systems: Develop and implement reliable systems for measuring and reporting progress on sustainability targets, ensuring transparent and credible data is available to demonstrate the company's sustainability performance to the lender. You can use Tese’s dashboard to do this.
- Engage Stakeholders for Sustainability Commitment: Ensure active engagement with internal and external stakeholders to secure support for the company's sustainability efforts. Communication is key.
- Seek Specialized Financial and Sustainability Guidance: Consider engaging sustainability consultants or financial advisors specializing in sustainability-linked financing to guide the company’s strategy and approach to meet the loan's sustainability criteria effectively.
- Align Fund Utilization with Sustainability Objectives: Clearly articulate how the loan funds will be strategically utilized to drive sustainability improvements and contribute to achieving the predetermined sustainability targets.
- Document and Emphasize Sustainability Achievements: Compile a comprehensive portfolio of sustainability achievements, initiatives, and future plans to demonstrate the company's commitment to sustainability and aptitude for meeting the loan’s specific sustainability criteria.
- Report Tangible Social and Environmental Impact: Explicitly outline how the company's sustainability initiatives have positively impacted the environment and society, utilizing specific metrics and evidence to reinforce the effectiveness of these initiatives.
- Maintain Transparent Communication: Ensure transparent and regular communication with the lender regarding the company's sustainability performance and the progress made toward meeting the loan's sustainability targets
