Environmental, social and governance (“ESG”) issues have become a more prominent factor in the Private Credit market in recent years as some investors seek to ensure their commitments are deployed in such a way so as to encourage ESG policies.

From a leveraged loan documentation perspective, the sustainability-linked loan (“SLL”) has evolved with the LMA, LSTA and APLMA jointly publishing the Sustainability-Linked Loan Principles (the “SLLPs”) in March 2019. The SLLPs provide guidance on the minimum standards for a loan to gain an SLL label. There are a range of issues for private credit lenders to consider, including:

  1. KPIs – the SLLPs include the requirement for the selection of KPIs and the setting of related sustainability performance targets (SPTs). The SLLPs also include a requirement for an independent external reviewer to verify the borrower’s performance against each KPI and SPT. The SLLPs encourage formulating a clear definition for the KPIs that should include scope, parameters, calculation methodology, a definition of a baseline and how it can be benchmarked against an industry standard. The SLLPs require that SPTs should be ambitious, represent a material improvement in the respective KPIs and be beyond a ‘business as usual’ trajectory and “regulatory required targets”.
  2. Reporting – How often should the KPIs be monitored and reported against? This typically aligns with the financial information reporting with a separate ESG compliance certificate being delivered annually (the SLLPs recommend that borrowers should report on their KPIs at least once per annum). The annual reporting requirement includes a “sustainability confirmation statement with verification report attached,” setting out the performance against SPTs and related impact on the Margin. The SLLPs specify that the independent external verification of performance should continue for the duration of the term of the loan (and that this verification must be conducted by a qualified external reviewer).
  3. Reward (and discipline) – The “reward” of a Margin reduction for achieving ESG targets is now well established, and so is the “discipline” of a Margin increase for each KPI not achieved (or failure to deliver the ESG compliance certificate). The SLLPs recognize that Margin is likely to go down if targets are met, but also up if they are not. It remains less common for underperformance with respect to ESG KPIs to constitute an Event of Default.
  4. Use of the benefit – Requiring the Borrower to use some or all of the savings that become available by virtue of the Margin reduction to reinvest in ESG initiatives can be a way of further improving the ESG credentials of the transaction for all parties (for example, 50% of the economic value received as a result of the reduction in the Margin to be used for sustainability-linked initiatives and/or charitable purposes over the course of the following Financial Year).