Sustainability Linked Loans (SLLs), unlike traditional Green or Social Loans, aren’t earmarked for specific projects but their interest rates are influenced by the borrower’s Sustainability Performance Targets (SPTs), making them an effective tool for driving ESG progress and risk management
Sustainability Linked Loans: A Path to Greener Financing
A Sustainability Linked Loan (SLL), frequently confused with Green or Social Loans, is a rapidly growing financing tool that stands out due to its flexibility in use. The unique characteristic that differentiates it from the Green or Social loan is the lack of earmarking for a specific environmental or social cause.
Exploring the World of SLLs, Green Loans, and Social Loans
Essentially, a Green or Social Loan allocates a certain amount of money explicitly for an environmental or social initiative. Conversely, an SLL breaks away from this mould, allowing the borrowed money to fund any expense, irrespective of its ‘green’ status.
The crux of an SLL is its motivational function in the implementation of Environmental, Social, and Governance (ESG) measures. Here, the interest rate corresponds to the borrower’s Sustainability Performance Targets (SPTs) KPIs, which can include parameters like water usage, waste management, electricity consumption, and workforce management.
In other words, an SLL symbolises the borrower’s dedication towards sustainability. The establishment of ambitious targets can act as both an incentive, through favourable interest rates upon target achievement, or a punitive instrument, increasing the interest rate beyond market standards if the targets are unmet.
Principles Governing SLLs
Given their unique structure, it’s crucial to adhere to several core SLL principles:
- Selection of KPIs: These should be relevant and clear, reflecting the borrower’s comprehensive business and sustainable strategy. They can be compared internally or externally to gauge the ambition level of the SPTs.
- Calibration of SPTs: SPTs should represent a material improvement and involve significant effort from the borrower, going beyond a “business-as-usual” situation. They must stay relevant during the loan term and align with external frames of reference, such as a verified ESG metric or a science-based reference point.
- Loan Characteristics: The purpose of an SLL is to modulate the interest rate based on the SPT achievement. Both lender and borrower must concur on the calculation methods for the interest rate discount or surplus, contingent on the SPT’s fulfillment.
- Reporting: Annual reporting is integral to evaluate the borrower’s progress, the KPI and target relevance, and overall feasibility. Disclosure about SPTs can be included in the borrower’s annual company report, although it’s not a prerequisite.
- Verification: An independent and external party must verify the borrower’s performance levels annually.
For borrowers, an SLL can be highly advantageous. The funds are unearmarked, providing flexibility, and the adoption of a sustainability strategy bolsters the company’s reputation and investor trust. Further, the firm is better equipped to meet the rising legal requirements for sustainability reporting. Importantly, an SLL may also provide discounted loans.
From the lender’s perspective, an SLL enhances their reputation amongst investors and the public. The ambitious targets set may even allow the lender to collect equal or higher interest rates than a regular loan if the borrower fails to meet the set targets. Moreover, if the borrower succeeds, the lender complies with increasingly stringent regulations for sustainability reporting, smoothing their path towards future mandatory requirements.
Thus, the real question is not “what does a lender gain with SLL?” but “what does a lender lose by refusing to adopt the SLL?”. Those who neglect to adopt SLLs risk lagging behind as sustainability goals become compulsory in the finance sectors, jeopardising their reputation and potentially losing borrowers as this system gains widespread acceptance.
- Sustainability-Linked Loans A Bridge to Connect Corporate Sustainability and Finance by Sustainalytics.
- The rise of green loans and sustainability linked lending
- SUSTAINABILITY LINKED LOAN PRINCIPLES (SLLP)
- Sustainability-Linked Loans: What They Are, How They Work and Why They Matter
- Retooling the bank for sustainable lending