LMA’s principles of green, sustainable and social lending – what more can be done?
The principles of green, sustainable and social lending of the LMA, what more can be done?
COP26 is presented as an important step for the transition to a sustainable future. The objective of the private finance work for COP26 is stated as simply: âEnsure that every professional financial decision takes climate change into accountâ.
While the stated goal may be straightforward, achieving this goal will require considerable international cooperation between the public and private sectors to put the right frameworks in place.
The Loan Market Association (“LMA“) have already played a leading role in helping to move this project forward. Their Green Lending Principles (“GLP“) were published in 2018, closely followed by the Sustainability-linked Loan Principles (“SLLP“) (2019). More recently (in 2021), they published their social lending principles (“SLP“) (2021). Please see the attached article Sustainability Lending and Green Lending in the Real Estate Finance Market (shlegal.com) for more information on the LMA’s Green and Sustainable Lending Principles. Please also see the following link to the LMAs to see the principles in their Full Documents (lma.eu.com).
These principles have generated a lot of interest in the industry and they have undoubtedly been well received. One of the main aims of the principles was to help encourage the UK financial sector to put more emphasis on green and sustainable benchmarks of potential loans, which is certainly being achieved.
In this article, we examine how further developments in the application of these principles could help generate further positive changes in the lending industry and achieve the goals of COP26 by creating a framework for the financial sector around reporting, risk management, returns and mobilization. .
1. Knowing that not respecting the principles of the AML does not mean that the loan lacks environmental or social benefits
Obtaining an LMA compliant ecological, sustainable or social loan is considered the âgold standardâ in its field and is a very strong indicator that the loan has genuine and meaningful green / sustainable / social credentials. However, many loans will still have these authentic and meaningful credentials even if they do not meet or fully match the strict requirements of the AML.
For example, in order to comply with the SLLP of the LMA, the borrower must obtain an independent and external verification of its level of performance against each sustainability performance objective. This is a requirement recently introduced by the AML with the aim of protecting the sustainability principles against green laundering, but which can have the effect of significantly increasing costs for the borrower. Since margin reductions are usually not huge (often around 10 basis points), there is often a reluctance to let these cost savings be used up by third-party verification costs. If a borrower has the expertise and processes to perform the verification on their own in a robust and honest manner and if it is done transparently, lenders may be happy to allow it. This would not detract from the sustainability benefits of the loan, and the loan may even have stronger sustainability credentials than an AML-compliant sustainability loan. Nonetheless, the absence of third party verification would mean that it could not be identified as being fully AML compliant.
Another example we came across of a loan that had all the correct green credentials, but still did not match the LMA’s GLP, came when a client asked us to consider whether a proposed loan would be GLP-compliant. The proposed loan was to be used to buy back investors in an existing green compartment, so that their funds would then be reinvested in a new green compartment (the proposed borrower). While this loan would clearly have strong green credentials (it invests in a green compartment), the GLP’s âpurposeâ and âreporting and monitoringâ requirements were unlikely to be met. The purpose of the proposed loan to buy back shares in a green compartment does not correspond perfectly to the BPLs, and it is difficult to see how the reporting and monitoring requirements of the LMA could be met given the distance between the loan and the real green projects. .
Not being able to qualify a loan of this nature as “AML Compliant” does not, in and of itself, mean that it still cannot truly and legitimately be described and marketed as a green, sustainable or social loan. The loan may well have many of the characteristics required by the AML principles and be of real and genuine benefit to the environment and to society. Provided that this is the case, there is no need to fear accusations of green-washing and it would still be perfectly correct and legitimate to promote the loan as being a green, sustainable or social loan.
2. Move towards industry standard certifications
Being able to measure a borrower’s compliance with green, sustainable or social loan criteria is a key requirement of all AML principles.
As such, a question often asked by our lending and borrowing clients is what criteria should be used to assess whether the loan has met its green or sustainability goals. Currently, there is a wide range of different certification criteria and standards. The lack of industry standard measurements and certifications can create uncertainty and opacity and could even lead to unintentional green-washing.
In addition, even relatively well-known certifications can generate divergent opinions about their suitability for measuring a green or sustainable loan. For example, although EPC certificates are common, they are not uniformly considered to be the best measure of a building’s energy efficiency, as they are actually a measure of “design intent”. ‘a building that does not necessarily correspond to the real energy efficiency of the building. .
However, acceptance of industry standard certifications and measurements is seen as a key step in moving towards more widespread application of AML principles. We anticipate that as the market for green and sustainable loans grows further, specific metrics and certifications will be established that will constitute an âindustry standardâ. For real estate, one of the most successful voluntary certifications, LEED which estimates that they certify over 1.85 million square feet of construction space each day provides an optional green building rating system, with a variety of rating systems targeting new projects, existing projects, interior design and even household properties. Likewise, BREEAM provides a sustainability assessment method that can be applied worldwide to assess developments, renovations and operations based on their overall ESG characteristics. These two measures are considered likely to show the way, especially given their global applicability. LEED and BREEAM are both used around the world and therefore constitute a global benchmark that can, in particular, help large multinational companies to assess their ESG credentials across all their branches in a uniform manner, rather than having methods of compliance. Individual ESGs which are only comparable at the national level.
3. Strengthening voluntary frameworks and standards
It seems clear from the stated objectives of COP26 that some voluntary frameworks and standards are likely to be strengthened and become mandatory in the future.
Building a private finance system for zero priority for private finance for COP26 highlights the importance of a reporting framework. The document talks about the implementation of a common framework built on the working group for climate-related financial disclosures (TCFD) recommendations. As it becomes mandatory for borrowers to comply with various climate-related financial information and other ESGs, this increased transparency and consistency will in turn inevitably drive and shape the due diligence and ongoing monitoring requirements of lenders. , while making it easier for a lender to measure a borrower’s compliance with targets, goals and metrics over the life of a loan.
The new rules usually add an unwanted layer of bureaucracy for a lender. However, a move towards coherent and internationally recognized frameworks for lending in the âgreenâ and âESGâ space could well serve to make life easier for lenders.
Even if we are still far from it, it is not difficult to envision a not so distant future in which it would be obligatory to respect sets of principles similar to those imagined by the LMA to market a loan as a “green”. loan, “a” sustainability loan “or a” social loan. “Lenders and borrowers who are already used to working with these principles will be well placed to adapt to any regulatory tightening in this area.
4. Talk to Stephenson Harwood
We advise both lenders and borrowers at all stages of their green, sustainable and social lending journey. This includes workflows such as:
- discuss with borrowers whether their environmental activities may be suitable qualifying criteria for a green or sustainability-linked loan;
- produce LMA compliant green loan documentation for lenders;
- advice on green and sustainable loan transactions;
- assist in a project to develop a climate change due diligence questionnaire for use by borrowers and lenders; and
- conduct training sessions on all aspects of green and sustainable loans.