Issue link: https://digital.shearman.com/i/1512772
Shearman & Sterling LLP Sustainability-Linked Loans: Key Considerations in Setting Key Performance Indicators | 52 KPIs based on indicators confirmed by external verification agencies face greater greenwashing risks if the selected agency itself is not credible. In the absence of established market practice and clear regulatory guidance, there are certain best practices for borrowers to consider to mitigate the legal and reputational risks in issuing SLLs: • KPIs should be relevant to the borrower's business and sufficiently ambitious, and not something the company could achieve anyway. For example, if a borrower has significant scope 2 and scope 3 greenhouse gas emissions (i.e., emissions from the supply chain or other sources not directly controlled by the company) but not scope 1 greenhouse gas emissions (i.e., emissions from business activities directly controlled by the company), then KPIs based on scope 1 greenhouse gas emissions would not be relevant or material to the borrower's business. • Exercise caution when using less standardized or assessable KPIs. Investors may find it difficult to assess the financial significance of certain ESG targets, especially when KPIs are linked to social indicators, which, compared to climate- related targets, lack international standards to use as benchmarks. Borrowers may need to rely on external verification or accreditation providers to a greater degree when using less standardized KPIs, but these providers may themselves lack market recognition or credibility and introduce greater reputational or litigation risks. • Pricing adjustments should be material. If achievement or failure to achieve certain performance targets only leads to a few basis points of pricing adjustment, the pricing adjustment is not a sufficiently meaningful incentive for the borrower to achieve sustainability targets. Similarly, if the SLLs only provide a discount when the borrower meets certain targets but no premium if the borrower's performance deteriorates, it may also call into question whether the sustainability label of the SLL is justified. • Ensure SLL-related disclosures are not misleading. When describing SLLs in the borrower's public disclosure, claims about the real-world impact of the SLLs and their reflection of the borrower's underlying sustainability profile should be carefully drafted to avoid overstatement. While SLLs represent an attractive option for borrowers of all industries to participate in ESG finance, they come with informational and monitoring costs and may introduce additional legal and reputational risks. Borrowers should consult experienced advisers in deciding whether and how to implement SLLs.