Green loan financing – taking root in fertile soil

Green finance is financing where the proceeds are used by a borrower in financing projects that make a contribution to an environmental objective. This is an important way in which finance markets are contributing to the objectives of the 2015 Paris Climate Agreement, seeking to align finance with low greenhouse gas emissions and climate-resilient development.

Green finance also provides borrowers, lenders and investors the opportunity to promote the green credentials of their operations and demonstrate a contribution to the achievement of their environmental, social and governance (ESG) objectives.

Green finance has been around in the bond markets for some time, and green bonds are generally required to comply with the Green Bond Principles published by the International Capital Market Association. The existence and use of the Green Bond Principles seek to create transparency in tracking funds to environmental projects and provide insight into their estimated impact.

Green Loan Principles

In the loan market sector, the Loan Markets Association (LMA), Asia Pacific Loan Markets Association (APLMA) and Loan Syndications and Trading Association (LSTA) have jointly published the Green Loan Principles.

The aim of the Green Loan Principles is to provide a consistent framework for what can be classified as a ‘green loan’.

Under the Green Loan Principles, green loans are loans made to finance (or refinance) new or existing green projects which align with the Green Loan Principles’ four core components.

These four core components are:

• Use of proceeds – the proceeds of the green loan must be used for a green project.
• Process for project evaluation and selection – this involves communication by the borrower of its:
  • environmental sustainability objectives;
  • processes for determining eligibility of projects; and
  • eligibility criteria and any exclusion criteria.
• Management of proceeds – the borrower must track the use of proceeds to the relevant green project, which is typically done via a dedicated account or ledger.
• Reporting – the borrower will report on green projects and their impact, and the application of the proceeds of the green loan.

Project selection

The Green Loan Principles set out a list of indicative categories of green projects which can be financed by a green loan. These indicative categories are based on the categories in the Green Bond Principles and include:

• renewable energy
• energy efficiency
• pollution prevention and control
• environmentally sustainable management of living natural resources and land use
• terrestrial and aquatic biodiversity conservation
• clean transportation
• sustainable water and wastewater management
• climate change adaptation
• eco-efficient and/or circular economy adapted products, production technologies and processes
• green buildings

Review and reporting

In a green financing, the borrower will need to arrange review of its green loan framework and its ongoing compliance with its sustainability objectives. In most cases, this review will be done by an external expert.

The Green Loan Principles contemplates various types of expert reviews of increasing rigor, which are described as:

• Consultant review – review and advice from a consultant, for example, a ‘second party opinion’ on the borrower’s green loan framework.
• Verification – verification of the green loan, green loan framework and/or green projects by an auditor or rating provider.
• Certification – certification of a green loan and/or green loan framework against an external green assessment standard, for example the Climate Bonds Standard published by the Climate Bonds Initiative.
• Rating – rating of a green loan and/or green loan framework.

The type of review and the identity reviewer in a green loan is a matter for agreement between the lender and the borrower. By way of example, this might involve a second party opinion on, or a certification of, the borrower’s green loan framework alignment with the Green Loan Principles, followed periodic reporting and verification during the course of the green loan.

The Green Loan Principles also contemplate the possibility for some borrowers with internal expertise to do the reporting or certification internally. This is something that might be acceptable to a lender where the borrower has internal expertise to do this. In these circumstances, the Green Loan Principles recommends documenting the internal expertise and making it available to the lenders.

Documenting green loans

The changes to a facility agreement to make it a green loan facility agreement are not extensive, and generally touch on application of proceeds, the process for project selection and reporting.

To assist in the documentation process, some suggested drafting for use in LMA-style facility agreements has been published by The Chancery Lane Project. These suggested provisions work with the four core components of the Green Loan Principles and are useful in providing a framework around which lenders and borrowers can negotiate the requirements for their loans to be classified as ‘green loans’.

Conclusion

Green finance seeks to align the finance markets with the achievement of a greener world. It encourages market participants to focus on green projects and to move away from other project types.

Gadens is pleased to have been involved in assisting our clients implement green loan facilities and are excited to contribute to this important aspect of achieving a greener world.

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Authored by: 

Matthew Trinca, Special Counsel