The term “Green loan” has become more and more omnipresent in economic and commercial discourse. what is a
“Green loan” and what sets it apart from your typical ‘to lend’?
Traditionally, a ‘to lend’ is identifiable as such if the instrument in question satisfies three fundamental financial and legal criteria, namely that the instrument prescribes a specific objective for which the funds advanced can be used; the instrument has a fixed term, at the end of which the funds advanced must be repaid; and, finally, the instrument assigns a financial cost to the whole business, usually through the charging of interest, whether fixed, variable or a combination of the two. Of course, if these criteria describe a classic vanilla loan, it is possible to structure a more complex loan, with more expensive or complex conditions.
A green loan is a form of financing that aims to enable and empower companies to finance projects that have a distinct environmental impact, or rather, that are oriented towards financing “Green projects”. However, the concept is broader in that it encompasses a green orientedmethodology throughout the green loan selection, structuring, use and reporting process. In this regard, while various methodologies of what qualifies as green loan or one green project can be postulated, the litmus test, or industry benchmark, is represented by the criteria set out in the
“Principles of green loans”, published in 2018 by the Loan Market Association (LMA), supplemented by the Guidance Note published in May 2020, The
Principles of Green Loans (“GLP”) create a high level framework of market standards and guidelines, providing a consistent methodology for use in the green lending market, while allowing this market to maintain its flexibility as it evolves. GLP are recommended non-mandatory guidelines to be applied by markets on a case by case basis, depending on the driving characteristics of the transaction.
The BPL framework sets out four defining criteria for the purpose of determining what makes a loan a green loan:
(1) Use of the product
An intrinsic component of a green loan is that funds are advanced to finance or refinance exclusively green projects. GLP establishes a non-exhaustive list of eligible projects, the common denominator being clearly identifiable and distinguishable environmental impact and benefits, which must be achievable, quantifiable and measurable, and include projects which aim to combat climate change, l depletion of natural resources natural resources, loss of biodiversity, as well as pollution control. Interestingly, according to the BPL Guidance Note, financing of green loans is not the exclusive preserve of purely green borrowers, noting that projects that significantly improve the efficiency of the use of fossil fuels are potentially eligible, provided that all other eligibility criteria are met and the borrower has embarked on a decarbonization trajectory aligned with the Paris Agreement (UNFCCC Climate Agreement 2016).
(2) Assessment and selection of green projects
In order to ensure the transparency and integrity of the selection process, BPLs define the key elements of the proposed green project that must be communicated by the potential borrower when applying for a green loan. A potential borrower should communicate, at a minimum, the environmental sustainability objectives of the project, as well as the process by which they have assessed that their project is considered an eligible green project. The assessment should be objective and balanced, highlighting the significant potential environmental risks associated with the proposed green project, as well as the green standards or certifications that the potential borrower will strive to achieve in order to offset those risks.
(3) Management and monitoring of product use
The third prong of GLP focuses on how borrowers manage the actual use of funds. BPL recommends that the proceeds of the green loan be credited to a dedicated account to promote fund integrity and allow the borrower to track outgoing flows. When a green loan takes the form of one or more tranches of a loan facility, each green tranche must be clearly identified and credited. In addition, borrowers are encouraged to establish an internal governance process through which they can monitor the allocation of funds to green projects. The borrower and the lender (s) must agree a priori whether an independent external review will be required to assess performance over the life of the loan. Practice demonstrates that when lenders have extensive working knowledge of the borrower and its business or when the borrower has sufficient in-house expertise, self-certification is considered appropriate. In the absence of such elements, a third party review is recommended.
(4) Reports
GLP promotes transparency in reporting by recommending that borrowers report, at least once a year, on the use of funds and the actual allocation of funds to green projects, as well as information on their environmental impact. GLP recommends a combination of qualitative performance indicators and, to the extent possible, quantitative performance measures (e.g. energy capacity, power generation, reduction / avoidance of greenhouse gas emissions, etc. ), as well as the methodology and / or key underlying assumptions underlying the determination.
Essentially, GLP defines a guiding taxonomy for the identification, selection and management of green loans and can be applied to various lending instruments, including green syndicated loans, green revolving facilities, green asset finance, green supply chain finance.
After exploring the main characteristics of a green loan, we now turn our attention to a critical assessment of their attractiveness to entrepreneurs and financiers. In fact, even though the economic drivers may differ among market players, the overriding motivation effectively remains the same – the realization of sustainable projects that have a positive environmental impact. From a reputation and corporate governance perspective, green loans can have a ‘halo effect’, enabling borrowers and lenders to tangibly demonstrate their commitment to the development of a sustainable economy, a commitment that has grown in importance with the heightened expectations of shareholders and stakeholders at large and market forces at stake, including the expectations of regulators and employees. In addition, green lending instruments allow borrowers to access a larger and more diverse pool of investors, especially those seeking environment, social and governance (‘ESG’) investments.
From a purely financial perspective, the general market trend observed is for lenders to charge lower interest rates to finance green projects, or the relaxation of financial or other covenants, prompting borrowers to adopt such instruments. In addition, there is evidence to suggest that borrowers operating on a sustainable basis are likely to have better risk management and good governance procedures in place, which translates into a better individual credit risk profile for them. borrower and an improved overall credit risk profile for lenders. From a regulatory capital perspective, although there is not yet a concrete regulatory advantage to green lending, the European Commission has opened the door to this possibility, announcing that it is studying the viability of a relaxation of capital requirements for this type of instrument in its communication on the European Green Agreement.
It is also relevant to consider the notion of
‘greenwashing’, a practice frowned upon in the green loan market and used to describe borrowers who present themselves as having green credentials and yet whose statements are misleading, inaccurate or exaggerated. Potential participants in the green loan market should be wary of the serious implications of green laundering practices, including the negative impact on investor confidence and the real threat of reputational damage or even litigation. In this regard, the BPL Guidance Note emphasizes that borrowers of green loans should ensure that the use of the product remains green throughout the life of the loan, and not just at the start of the loan drawdown.
Looking to the horizon for the green loan market in the years to come, promising indicators abound. For example, the European Investment Bank (EIB) has made the fight against climate change and environmental protection one of its pillars, with no less than 25% of its annual investment program devoted green projects, including the protection of biodiversity, sustainable transport and renewable energy projects. In addition, the European Green Deal investment plan, presented in January 2020, sets out an ambitious investment mobilization plan to trigger a wave of green investments of up to € 1 trillion from public and private sector funds to channel to achieve the EU’s commitment to become the first climate neutral bloc by 2050. At the local level, the Malta Development Bank (MDB), created in November 2017, has as its founding objective the promotion of economic growth inclusive and environmentally sustainable. To this end, the BMD has, among other initiatives, integrated social and environmental factors into its investment and risk assessment processes, and has identified the financing of green projects as one of its strategic pillars, with investments in renewable energies and energy efficiency at the forefront of this strategy.
With a booming environmental awareness, the green loan The market has continued to strengthen, enjoying year-over-year growth and attracting an ever-increasing number of banks and other financial institutions to the green lending market. In recent months, we have seen a gradual evolution of the concept of green lending, with green loans evolving into more complex lending instruments, better known as “Sustainability loans” or “SLL”. SLLs will be the subject of our next publication in this Sustainable financeseries.
The content of this article is intended to provide a general guide on the subject. Specialist advice should be sought regarding your particular situation.
