Shearman & Sterling LLP 49 | Sustainability-Linked Loans: Key Considerations in Setting Key Performance Indicators
Sustainability-linked loans (SLLs) aim to encourage
better environmental, social and governance (ESG)
business practices by adjusting loan pricing based
on the borrower's performance against certain ESG
metrics, or key performance indicators (KPIs). Unlike
green loans, a popular form of ESG finance that
requires loan proceeds be used to fund specific
environmental projects, SLLs are more flexible. The
range of KPIs against which a borrower's performance
can be tailored to the borrower's size, industry and
operations, allowing borrowers from hard-to-abate
industries to take advantage of the ESG-focused
financing market.
However, the SLL market is far from mature. There is no
established market practice or regulatory framework,
and SLLs can introduce reputational and legal risks to
borrowers if the KPIs are not sufficiently robust or rely
on external verifications that are not highly credible.
In this article, we provide an overview of SLLs, discuss
current market practice and regulatory environment,
and offer practical suggestions in designing KPIs.
BACKGROUND
Since their debut in 2017, SLLs quickly became a
popular form of ESG finance. SLLs' issuance reached
$366 billion in 2021, which was 181% above the 2020
volume.
1
SLLs' popularity is in large part due to its
flexibility. They do not require loan proceeds to be
used toward specific ESG projects and therefore
allow borrowers outside of typical "green" industries
to participate in ESG finance and signal their ESG
commitment to customers, suppliers, shareholders
and other stakeholders. Borrowers can tap into
the ESG-focused investor and lender base while
maintaining the flexibility of debt issuance for
general corporate purposes. SLLs also benefited
from the publication of the voluntary, non-binding
Sustainability-Linked Loan Principles (SLLPs) by the
Loan Market Association in the United Kingdom, the
Loan Syndicated and Trading Association in the United
States and the Asia Pacific Loan Market Association
in Hong Kong in March 2019, which provided much
needed standards and guidance to the nascent market.
However, the SLLPs are voluntary, high-level guidelines
that leave many operational nuances unaddressed,
and they do not seem to have had any significant
impact on the SLL market itself. The SLLPs are seldom
referenced in SLL credit agreements. Among the
264 publicly filed SLL credit agreements between
January 1, 2022 and October 22, 2023, only 63, or
about 23.8%, expressly refer to the Sustainability-
Linked Loan Principles.
2
The selection of KPIs and
performance targets varies significantly, and investors
and regulators alike are increasingly wary of SLLs'
greenwashing risks (i.e., the risk that the sustainability
label does not accurately reflect the sustainability
profile and commitment of the borrower). Some SLLs
drew questions as to whether KPIs were sufficiently
robust to justify the sustainability label. For example,
Sustainability-Linked Loans:
Key Considerations in Setting
Key Performance Indicators
Gus Atiyah and Ashley Shan
1
See Raquel de la Orden and Ignacio de Calonje, "Sustainability-
Linked Finance – Mobilizing Capital for Sustainability in Emerging
Markets," EMC Compass, https://openknowledge.worldbank.
org/server/api/core/bitstreams/2966e508-5347-537e-a493-
7632d2725a9f/content#:~:text=Launched%20in%202017%2C%20
it%20has,of%20total%20issuance%20to%20date (January 17, 2022).
2
As searched on October 22, 2023 on Intelligize. Search terms are
(i) ("sustainability" w/10 "adjustment") (to search for all loans with
a sustainability pricing adjustment) and (ii) ("sustainability" w/10
"adjustment") AND "sustainability linked loan principles" (to search
for all such loans that expressly reference the Sustainability-Linked
Loan Principles).
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