New LMA Provisions for Sustainability Linked Loans

The Loan Market Association has recently published draft provisions for sustainability linked loans. Financial Services partner, Muireann Hernon reviews these provisions and what they mean for borrowers and lenders.

The Loan Market Association (LMA) published draft provisions (the Draft Provisions) for sustainability linked loans, or SLLs, on 4 May 2023. These provisions are a welcome advancement as there has been no standard drafting prescribed by the LMA since the publication of the first sustainability linked loan principles in 2019 and the associated guidance in 2020. The absence of such drafting has resulted in varying positions across the market in how SLLs are documented.

You can read our previous article about the distinction between SLLs and Green Loans here

Scope of the Draft Provisions

The Draft Provisions track the latest version of the Sustainability Linked Loan Principles (SLLPs), published in February 2023. The LMA periodically updates these principles and the introduction of prescribed drafting, which can be adapted for use with any of the LMA recommended forms of facility agreement, will offer further clarity and consistency in this area. However, the Draft Provisions are intended to provide a framework only and are not prescriptive on certain negotiating provisions, for example, the flexibility for lender consent. This still gives the parties flexibility to agree on these positions on a transaction-by-transaction basis.

The key provisions are:

• The key concept is the ‘Sustainability Margin Adjustment’. On the achievement or failure to meet a set of defined targets, the interest margin will either increase or decrease. This margin adjustment, as in the case of a margin ratchet based on financial covenants, can amend the margin based on the number of targets achieved, or indeed based on the failure to meet any targets.

• The defined targets known as Sustainability Performance Targets, or SPTs, are a set of pre-agreed key performance indicators (KPIs) to be achieved in an agreed time frame. These KPIs, and the number of them, can be varied for each transaction as appropriate. Lenders and borrowers will need to have regard to the SLLPs and the associated guidance in the selection of an appropriate KPI.

• An external reviewer can be set for all KPIs or a different reviewer for each KPI. The Draft Provisions anticipate that this would be an independent professional services firm. There has been some recent criticism of alleged ‘greenwashing’ by financial services firms who have pledged to reduce emissions while still financing or investing in unsustainable industries. An independent third party reviewer is likely aimed at addressing this behaviour. The calculation methodology to be used in deciding whether a KPI has been met is also to be agreed in advance.

• The SPTs can be updated or amended on the occurrence of a Sustainability Amendment Event such as the sale of an asset. This facilitates updating the SPTs as the borrower’s sustainability performance progresses so that the SPTs in the loan agreement are not less ambitious than a new target publicly announced by the borrower.

• A periodic Sustainability Compliance Certificate will be required to be delivered by the borrower certifying the borrower’s performance in meeting the SPTs. This performance is assessed in accordance with the agreed calculation methodology. The Sustainability Compliance Certificate provides that a sustainability report prepared by and on behalf of the borrower and a verification report from the external reviewer will each be attached to the certificate to evidence the borrower’s performance.

• Following a Declassification Event all sustainability provisions, including the Sustainability Margin Adjustment, will permanently cease to apply. The LMA does not provide a list of potential Declassification Events and emphasises that these should be drafted on a case-by-case basis, but gives as examples consecutive non-achievement of SPTs or a Sustainability Breach (see below). A borrower cannot describe a loan publicly as a SLL following a Declassification Event.

• A Sustainability Breach is a breach of the sustainability provisions of the loan. The Draft Provisions are clear that a breach of the sustainability provisions is not to be considered an Event of Default, which is in line with the market position for sustainable lending.

• The borrower represents that all Sustainability Information, which is solely information given in connection with a Sustainability Compliance Certificate, is true, complete and accurate in all respects. Lenders may wish to consider including this as a repeating representation, although this will also likely require further third-party verification and may be negotiated out by the borrower.

Conclusion

The introduction of standard drafting for SLLs will give further clarity to the sustainable lending market. The Draft Provisions can be used as a starting point for negotiations in what is a developing area, and while we expect lenders and borrowers will have deal-specific requirements that will need to be incorporated into the terms, it will be helpful to have a common frame of reference when drafting loan documentation. Like the SLLPs and associated guidance, we expect the Draft Provisions to evolve in line with developing market practices.

For more information on successfully navigating and negotiating sustainability linked loan documentation, contact a member of our Banking or Financial Services teams.

The content of this article is provided for information purposes only and does not constitute legal or other advice.