Sustainability and ESG are increasingly becoming essential considerations across all industry, private debt included, and this week has seen the European Leveraged Finance Association and Loan Market Association publish a best practice guide for sustainability-linked leveraged loans.
Some lenders have already taken steps to provide loan documentation that reflects sustainability concerns by providing discounted interest, provided ESG targets are met, to encourage the businesses they support to become more sustainable. With LPs also increasingly seeking strong ESG credentials among the managers they invest in, ensuring portfolio companies are similarly incentivised to adopt ESG criteria has become essential.
ELFA and LMA said their guide “provides practical guidance as to the application of the Sustainability Linked Loan Principles to ‘ordinary’ leveraged loans which seek to incorporate any kind of ESG factor or metric.
“It also sets out what borrowers, finance parties and their respective advisers should consider when looking to integrate sustainability factors into their loan agreements.”
Among the areas addressed in the best practice guide are terminology, roles, KPI selection, reporting and documentation.
The associations said the common language that has evolved around sustainability can be daunting and act as a barrier to entry, which is why it has provided a glossary of terms common to sustainability lending projects.
Adopting sustainability into loan documents has also seen specialised roles evolve, including ESG rating providers, ESG consultants, sustainability coordinators and external reviewers, all of which are explained in the guide.
Perhaps the most important aspect of introducing sustainable loans is setting appropriate KPIs against which to judge whether a firm is acting sustainably. Providing materials which help firms demonstrate a meaningful commitment to ESG, including KPIs and associated sustainability performance targets, should help to ensure lenders and borrowers are on the same page with regards to how they can act in a sustainable manner.
Borrowers will also need to ensure they are able to properly report on how they are meeting their sustainability targets.
Lastly, documentation is important to ensure ESG considerations are properly written into loans. However, due to the varied nature of the market, no template wording currently exists. The guide seeks to outline some considerations firms may wish to consider when drafting term sheets and loan facilities.
Recent years, and particularly the past 18 months of the global covid-19 pandemic, have demonstrated that sustainability and ESG are here to stay and have become key metrics by which firms of all sorts measure their performance, particularly major institutional investors. While one might expect economic concerns to prevail in tough market conditions, that has not happened in this economic cycle, with both industry and politicians demonstrating that ESG concerns are here to stay.
Firms that aren’t integrating ESG and sustainability into their loan documents may find themselves increasingly left behind.