LMA provides new guidance on external review process for Sustainability-Linked Loans

The external review guidance

The external review has a central role in ensuring credibility for third parties in sustainable lending transactions. ¹

Types of external review

Due to the variety of available types of external review in both scope and underlying methodology, the Guidance looks at the three following overlapping forms of review, in turn:

1. Second Party Opinion;
2. Verification; and
3. Sustainability-Linked Loan Scoring/Rating.

Second Party Opinion (SPO)

An SPO will most commonly be provided prior to execution, although in rare instances it may be requested post-execution. 

Pre-execution

The SPO should be transaction-specific but will usually involve an assessment prior to execution which establishes how closely the project’s sustainability-linked loan framework aligns with the SLLP. To assess alignment, the SPO may look to borrower-specific information like long-term sustainability targets and/or any specified taxonomy. 

For sustainability-linked loans, SPO providers may, amongst other things, assess: 

a. the “relevance, materiality, robustness and reliability” of key performance indicators (the KPIs) that have been chosen for the transaction both from a sector and/or borrower perspective; 

b. the “rationale and level of ambition” of the sustainability performance targets (SPTs) chosen for the transaction; and/or 

c. the “relevance and reliability” of the benchmarks and baselines chosen to measure the KPIs and SPTs. This would also assess the “credibility” of the framework for achieving these objectives through analysis and assessment against external references.

Post-execution

Exceptionally, an SPO may be provided following execution of the transaction, as a “condition subsequent” to drawdown. Here, the sustainability-linked loan classification would only be granted subject to the post-execution SPO being provided. 

Verification

This process involves a high-level review by an independent third party using a detailed set of external criteria. This is usually seen as more detailed than an SPO and differs in that it uses a specified external standard.

In sustainability-linked transactions, independent and external verification of the borrower’s performance against the respective SPT for each KPI is mandatory (at least once per year) until the point of the last SPT trigger event as set out in the loan documentation. 

The Guidance discusses three types of verification as market standard:  

• assurance;
• attestation; and
• certification

Assurance

The LMA cites two levels of assurance used for sustainable lending transactions: 

1. limited assurance – most commonly used in loan markets but not possible for every KPI and can be difficult to obtain. This relies on a review of a sample of raw underlying data.
2. reasonable assurance – a higher standard of assurance requiring a more detailed review of underlying data as well as the procedures and methodologies used to derive this data.

Assurance will often, but not always, contribute towards an audit report.

Attestation

The Guidance discusses attestation or assertion-based engagement as an additional verification option. Here the external reviewer would provide an assurance conclusion in the form of an assertion which is founded on the evaluation of the subject matter. This is not common for sustainability-linked loans but can be used for green and social loans.

Certification

The borrower may decide to have one or several of the following aspects certified against the selected criteria: 

1. sustainability-linked loan;
2. sustainability-linked loan framework;
3. use of proceeds; and/or
4. KPIs and/or SPTs.

Certification would produce a score or label that would, in turn, facilitate greater comparison for third parties. The score/label may also be linked to the definition of specific KPIs in sustainability-linked loan transactions.

Sustainability-Linked Loan Scoring/Rating

Following the external review, a rating or score may be provided based on the sustainability-linked loan. The subject of this rating/scoring may be:

1. the borrower itself;
2. the sustainability-linked loan and/or the sustainability-linked loan framework; and/or
3. an aspect of the loan, such as selection of KPIs and/or calibration of SPTs to the KPIs.

Any rating provider should explain their methodology clearly to the borrower. It is integral to the robustness of the rating that it is assessed by a recognised third party.

Ethical and professional standards for external reviewers

The LMA has suggested five central ethical and professional principles that should underpin the work of the various bodies tasked with an external review: 

1. “integrity”;
2. “objectivity”;
3. “professional competence and due care”;
4. “confidentiality”; and
5. “professional behaviour”.

The reviewers must be independent from the borrower’s adviser for the sustainability-linked loan framework and should not be an affiliate.²  The external reviewer may already be subject to their own internal professional standards that coalesce with the LMA’s suggestions.³

Organisation of external reviewers

The LMA suggest the following pre-requisites for any external reviewer – it should:

1. “have an organisational structure, working procedures, and other relevant systems for carrying out the external review”;
2. “employ appropriate staff with the necessary experience and qualifications for the scope of the external review being provided”;
3. “if applicable, carry the appropriate professional indemnity/professional liability insurance cover”; and
4. “be regularly engaged in the application and monitoring of relevant ESG standards and ESG calculation methodologies”.

Where an SPO is required for a sustainability-linked loan, the external reviewer should have expertise in the chosen KPIs, SPTs and other relevant SLLP architecture for the sustainability-linked loan transaction. It may also be important to have expertise in any relevant climate change strategies or governance and science-based methodologies for review.

Content of external reviews

The LMA establishes a set of points that external reviews should, at a minimum, include: 

1. “a general description of the objective, scope of work, the procedures conducted and the external reviewer’s credentials”;
2. “where relevant, the requisite credentials to evaluate [...], for sustainability-linked loans, KPIs, SPTs and related benchmarks, baselines […]”: 
3. “a statement on independence and conflict-of-interest policy”;
4. “details of definitions, analytical approach, criteria and/or methodologies used”
5. “the conclusions or output of the external review report, including any limitations on the external review”
6. “where applicable, the level of verification and a description of any relevant international professional standards to which such verification will be aligned”⁴ ; 
7. “where applicable, whether or not the borrower has allocated green and/or social loan proceeds according to its predefined eligibility criteria”.

Second Party Opinion

If an SPO is included, the LMA recommends outlining the scope of the SPO clearly. Within the scope, the SPO should indicate whether it is complete (assessing alignment of the loan’s framework with the key aspects of the SLLP) or partial (assessing alignment with a selection of the key aspects of the SLLP). 

Verification

Any verification report should include as a minimum: 

1. requisite level and nature of verification⁵;
2. description of verification procedures and any procedural shortcomings;
3. outlining of the subject matter and assessment criteria; and
4. confirmation of independence and alignment with a quality management system.

Where information has already been verified for an alternative audit or regulatory process, it is unlikely that this will need to be re-verified for the SLLP.

Sustainability-Linked Loan Scoring/Rating

The report may produce a score or rating that is linked to a specific benchmark. This should be distinct from credit-rating used for the transaction.

Disclosure for external reviews

The LMA suggests that the external review should be released to all finance parties in accordance with the terms of the loan documentation, the SLLP and guidance documents. The release of a publicly available external review is encouraged, where appropriate, but any disclosure should be sensitive to confidentiality and competition points within the transaction.

Conclusion

The update to its external review guidelines evidences the LMA’s continued efforts to create a shared and consistent language between the relevant players in sustainability-linked loans. However, flexibility remains central to the LMA’s advice, as evidenced by the variety of standards and frameworks mentioned in the Guidance. As a result of this flexibility, lenders should think clearly about the requirements of their deal and tailor the scope of the external review appropriately. As sustainability-linked and green loans continue to proliferate in global markets, it is possible that external reviews, and even the loans themselves, may become subject to regulation. In the meantime, the Guidance provides a useful reference guide for the market on external reviews.