What do you need to know about the new LMA drafting for sustainability-linked loans?

Background

Since the first publication of the LMA Sustainability Linked Loan Principles (SLLP) in 2019 and the related LMA Guidance in May 2020, there has been no standard drafting available, which has resulted in a variety of approaches in how the SLLP are implemented in loan agreements. The SLL Provisions are intended to be a response to this gap by providing a starting point for drafting a sustainability-linked loan (SLL) without providing a comprehensive analysis of SLL transactions - they intentionally omit several features which are commonly negotiated between parties from time to time. 

The SLL Provisions are published as a bolt-on, designed to slot into the LMA Senior Multicurrency Term and Revolving Facilities Agreement for leveraged acquisition finance transactions (senior/mezzanine) and can also be adapted for use in conjunction with the LMA's other recommended forms of facility agreement.  They are aligned with the latest SLLP and accompanying Guidance.

The basics of how the drafting works

• The key obligations are described as the Sustainability Provisions, breach of which does not trigger Events of Default but instead triggers pricing differentials via the Sustainability Margin Adjustment and/or ultimately a declassification of a loan as sustainability-linked. 
• Sustainability Margin Adjustment: the pricing of the loan is adjusted by reference to a borrower’s performance against Key Performance Indicators (KPIs) in accordance with published ESG Standards (if available), and Sustainability Performance Targets (SPTs) in relation to each KPI. 
• There are key Sustainability Provisions including:
  • A “No misleading Information” representation that all Sustainability Information was true, complete and accurate in all material respects as at the date it was provided and is not misleading in any respect. This is not deemed to be repeated on drawdown dates or interest payment dates, but instead on dates of Sustainability Compliance Certificates provided for SLL Reference Periods.
  • The provision of Sustainability Information, Sustainability Compliance Certificates, Sustainability Reports and Verification Reports to allow for reporting, testing and verification of the borrower’s performance against the SPTs.
• A breach of the Sustainability Provisions triggers a deemed failure to meet the SPTs, so that either the margin reduction is not applied (in a one-way ratchet) or there is a margin increase (in a two-way margin ratchet). 
• Following a Sustainability Amendment Event (broadly triggered by asset disposals or acquisitions, mergers or acquisitions which materially affect the KPIs or SPTs), the lenders and borrower enter a period of good faith negotiations to agree such amendments to KPIs, SPTs, calculation methodologies or related provisions to accommodate the consequences of such an event.  If amendments cannot be agreed by an agreed deadline, the lenders have the ability to declassify the loan as no longer being sustainability-linked (a Declassification Event). Then the borrower can no longer market the loan as an SLL and most importantly the banks’ green-washing risk is mitigated.

Key points to note

The SLL Provisions are described by the LMA as being “based on market practice at the time of publication”. However, in our experience there is a wide variety of market practice, and some of the SLL Provisions are not as strict as the terms we are used to seeing in the market. However, the LMA is clear that the SLL Provisions act as a framework, and there is considerable scope for negotiating a range of items (including the KPIs / SPTs, how and when they are tested and verified, levels of lender consent to agree changes, and the consequences of non-compliance), so long as the core components of the SLLP are complied with.

Repeating representation

Banks may wish to consider requiring a repeating representation and/or undertaking regarding the facility complying with the SLLP. This is not included in the SLL Provisions (perhaps because of reliance on the “second party opinion” (or SPO) provided by an ESG consultant, which the SLLP recommends being included as a CP to drawdown). However, this kind of representation/undertaking has often been seen in the market. 

If the parties decide that such a repeating representation and/or undertaking will be included, a further issue arises - should this refer to the SLLP in force on the date of the facility agreement, or the SLLP in force from time to time?

The latter approach in effect incorporates the latest version of each update and may necessitate annual amendments to keep up with updates to the SLLP over the life of the loan (which may be administratively burdensome (or even unworkable) given that the LMA typically publishes updates to the SLLP only a few weeks before they come into force). This may require a borrower to update and amend its internal procedures as well as the information provided to lenders, to ensure the loan can comply with (and be labelled as compliant with) the latest version of the SLLP at any given time.

Declassification Events

It is worth noting that, although the Declassification Event is narrowly drafted, there are square brackets and a footnote making it clear that parties can include other Declassification Events in addition to the single event included in the SLL Provisions - failure to agree amendments by a deadline following a Sustainability Amendment Event. 

The LMA states that “users should consider all additional declassification events in the context of the relevant KPIs and the specific circumstances of the transaction, as well as market practice at the time”.

Certainly, many lenders will want to consider extending the definition to include further categories of Declassification Events, in particular in relation to a (persistent) failure by the borrower to deliver sustainability reporting.

Consequences of a Sustainability Breach

Lenders may consider whether a serious Sustainability Breach is sufficiently serious and/or persistent such that it should trigger an Event of Default. The sustainable lending market is still relatively benign for borrowers, so Sustainability Breaches rarely (if ever) trigger Events of Default, but this is something which lenders are increasingly looking at, given that practice regarding breaches is likely to change as bank assessments of the sustainable impact of their financings becomes increasingly core to credit approval processes in response to developing regulatory and reporting requirements.

Margin Ratchet

The drafting of the SLL Provisions assumes that the whole loan is a SLL (which is generally, but not always, the case) and the margin is adjusted based on the number of SPTs met. However, there are many other approaches which would also work by way of pricing adjustments, including allocating a particular margin adjustment for each SPT and then netting off to determine the final adjustment, or incorporating a ‘blended ratchet’ (i.e., a multi-tiered margin ratchet with the margin varying at differing SPT 'thresholds', or a margin ratchet which is structured in a way that affords greater weight to the achievement of particular SPTs).

Lender threshold for decision making

The SLL Provisions allow the parties to require an All Lender or Majority Lender decision for both negotiating and agreeing with the borrower any Sustainability Amendments over the term of the loan, and also any declaration of a Declassification Event. Lenders will need to give full consideration as to which they elect for, with the risk that All Lender consent is unwieldly for large syndicates, but given the significant green-washing risk for a bank of allowing a compromised loan to continue to be labelled as an SLL.

Conclusion

Developing standard drafting in a private market which is evolving so rapidly was always going to be challenging. While certain assumptions had to be made in preparing the SLL Provisions which will not be true for all transactions, it is hugely positive for the market to finally have standard drafting to use as a starting point for negotiations. We expect to see some market participants taking different positions on some topics, but using the same basic format and terminology can only help the market as a whole. SLLs are a rapidly evolving loan product, and we understand that the LMA intends to review the drafting in 6-12 months. We look forward to continuing to track this exciting market.

Further Information

• If you would like further assistance on understanding these changes, please contact David Milligan, Katie Knight and Rebecca Oliver.
• Our ESG Loans Insights Report identifies market trends based on the data contained in over 60 green loans, social loans and sustainability-linked loans we have advised on.
• If you would like to receive future ESG and Sustainability related content from us, you can subscribe here. More about our ESG and Sustainability practice can be found here.