June 2, 2021 - by Tess Virmani. 2021 has seen a meteoric rise in sustainability linked loans (SLLs). At the end of 1Q21, Refinitiv LPC recorded $77.6 billion of global SLL (aka ESG-linked loan) volume – a 17.5% increase quarter on quarter and a new high. And, record-setting volumes have continued. In their May Green Lending Review, Refinitiv LPC reported that $231 billion in global green and ESG-linked loan volume had come to market YTD – volumes that exceeded the full year 2020 totals – setting yet another record. SLLs continue to represent the majority of that volume. What is perhaps most remarkable is that US activity has grown exponentially. While the majority of global volume continues to come out of EMEA, Refinitiv LPC recorded $48.9 billion in US investment grade ESG-linked loan activity at the end of April, significantly above the $275 million booked in all of 2020. In light of this continued growth, the LSTA, together with the APLMA and LMA, have updated the Sustainability Linked Loan Principles (SLLP) and the accompanying guidance document to reflect market developments.
The SLLP were first launched in March 2019 as a voluntary framework to support the development of a then-new loan structure – the sustainability linked loan. A sustainability linked loan is not determined by their use of proceeds, rather the loan includes an economic incentive, typically a discount in the interest margin, for the borrower’s improvement of its sustainability profile. This is accomplished by the borrower and lenders selecting meaningful key performance indicators (KPIs) that are core to the borrower’s business and then agreeing on an ambitious sustainability performance target (SPT) for each of those KPIs. If the borrower meets the SPT, the interest margin is reduced. Careful consideration with respect to the selection of KPIs and the setting of SPTs is critical to preserving the integrity of the SLL. The SLLP guidance document specifically addresses how borrowers and lenders can ensure KPIs and related SPTs are ambitious and suitably meaningful to the borrower’s business: several independent organizations offer guidance on materiality issues by industry sector and/or company, including the Sustainability Accounting Standards Board (SASB). SASB has recently published on how SASB’s Materiality Map can support SLLs.
The 2021 updates principally seek to further the goal of the SLLP – to preserve the integrity of SLLs – by strengthening the language regarding the selection of KPIs and scope of SPTs to provide greater clarity as to expectations for new entrants to the market. This effort is reflected in the shift to requiring independent, external verification of a borrower’s performance level against each SPT for each KPI. This shift, as well as some structural adjustments, allows for the SLLP to be aligned, where appropriate, with the Sustainability Linked Bond Principles maintained by ICMA. This alignment ensures that companies have access to either the bond or loan markets on a refinancing. Moreover, as the popularity of SLLs continues to grow we are seeing SLLS move into new loan market segments. One of the key trends in 2021 has been the explosion of ESG-linked leveraged loans. Refinitiv LPC has recorded nearly $8.3 billion of global ESG-linked institutional volume, predominantly in Europe, in the first quarter of 2021 alone. As the SLL structure is adopted more broadly, ensuring that lenders have the transparency they need is critical.