In our January issue of REF News & Views, we discussed some key recent ESG developments in Europe and the UK in financial markets. We want to continue this over the next few months with a series of articles in which we consider ESG in greater depth by delving into the emergence of “green lending” and the principles of green lending – those principles that seek to form the framework market standards, guidelines and methodology to be adopted across the green lending market.
Ultimately, as the world moves towards a greener and more sustainable future, UK lenders and businesses are increasingly aware of their impact on climate change and the environment through their investments and their lending activities. This is due in part to higher levels of regulation and government-imposed responsibility for sustainability, as well as an increased global awareness of the issues that surround climate change and the environment. This led to the creation of the Green Lending Concept and Green Lending Principles to help serve as a roadmap to sustainable investing and align the financial system with the UK’s ambitious net zero commitments.
What is a green loan?
A “green loan” is not a clearly defined or regulated term, but is often used in financial markets as a general term to describe loans made with a view to green and sustainable lending. This may be reflected in the underlying investment in the green project, product management and reporting, but is otherwise related to the use of loan proceeds for an eligible green project.
It should be noted that a sustainability linked loan (“SLL”) should be differentiated from a green loan. An SLL focuses on the behavior of the borrower as opposed to the project itself, in which the loan will be designed to incentivize the borrower to achieve certain key performance indicators based on sustainability and a commitment to reduce environmental impact . These could include commitments related to energy efficiency and the sourcing and use of sustainable materials and supplies. We will discuss SLLs in more detail in future articles.
The principles of green lending
In March 2018, the Loan Market Association (“LMA”) first published its Green Loan Principles (“GLPs”), which aim to facilitate and support environmentally sustainable economic activity by providing a framework of standards , guidelines and market methodologies that can be consistently adopted in the green loan market. The LMA continues to update the GLPs, with the latest version being published in February 2021, where it included social risks as one of the categories to be considered when assessing the project.
When should GLP be applied?
Although GLPs are recommended for green loan products, they are currently still voluntary and indicative only, intended to be applied by market participants on a case-by-case basis depending on the underlying characteristics of the transaction. It is therefore up to lenders to set their internal standards for eligibility criteria for what they would call a green project.
That being said, a growing number of national and international measures and initiatives are being discussed, created and imposed on corporate governance, climate change and sustainability that are beginning to change the way businesses and financial markets operate and discuss their activities. As such, with growing socio-economic pressures, we expect to see continued growth in the use of GLP as a guiding principle for green lending products, as well as evolution and development of GLP, over the years to come.
To be considered a GLP-compliant green loan, such a loan product must align with the following four basic components:
- Product use
- Project evaluation and selection process
- Revenue management
We’ll discuss each of the four core components in more detail in next month’s edition of REF News & Views.