ESG in Trade and Export Finance | Sullivan and Worcester

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[co-author: Theodora Okocha]

Ecology, social sphere and management (ESG) is currently at the forefront of discussions on trade and export finance, but its application in this area is still unclear. At a time when big money is moving from traditional financing to sustainable financing, market participants want to know how to effectively implement (and document) ESG in their transactions.

In this blog post, we’ll take a look at some of the key ways ESG have influenced trade and export finance, including environmental and social loans, sustainability-related loans, and striving to create market standards that align with ESG principles.

ESG lending growth

ESG lending has grown significantly in recent years, with Bloomberg LP reporting an increase in ESG bond and loan issuance from $ 26.6 billion in 2013 to $ 732.1 billion in 2020. Notably, growth in sustainability-related loans has outpaced growth in green loans. (both described below) in recent years.

The UK government is providing significant support to sustainable projects with the UK Export Credit Agency (UKEF) Contribution of £ 2.4 billion to sustainable projects in 2020 and an additional £ 2 billion from the UK government to support the UKEF Net Growth Direct Lending Facility for “net growth” and “green” projects.

ESG Categories and Matrix of Principles

Many ESG categories have emerged in recent years, including green projects, social projects, green loans, sustainable loans, blue loans, social loans, hybrid sustainable loans / green / blue / social loans, light green loans and brown designs.

Against this background, a number of principles have been developed to provide guidance on ESG funding. These include the Green Credit Principles (GLP), Principles of Social Credit (SLP), Linked Loan Principles for Sustainable Development (SLLP), The UN Principles for Financing a Sustainable Blue Economy, the Equator Principles and the IFC Environmental and Social Performance Standards. Various lending principles aim to ensure consistency in the ESG loan market.

What are green and social loans?

Green Loans are provided solely to finance or refinance, in whole or in part, new and / or existing eligible Green Projects. Likewise, social loans are available exclusively for financing or refinancing social projects. Green projects address issues of environmental concern such as climate change and air, water and soil pollution. Social projects address social issues such as affordable housing and access to basic services.

To qualify as a green or social loan, a loan must meet GLP or SLP requirements, respectively. Each set of principles has the following four main components that must be met:

  1. Use of income;
  2. Project appraisal and selection process;
  3. Income management;
  4. Making report.

A key feature of both green loans and social loans is the use of proceeds – they should be used for a green or social project. The project appraisal and selection process requires clearly communicating to lenders how the proposed project fits into an acceptable green or social project. Loan proceeds should be clearly segregated from any other funding through a separate account. Segregation of funds is key and should be controlled as part of the internal management process so that money can be clearly tracked and reported. Lenders also expect detailed qualitative and quantitative disclosures from borrowers. This should include indicators and performance indicators, as well as disclosure of the methodology used and assumptions.

The fact that a green or social project is funded does not in itself turn a major loan into a green or social loan unless all GLPs or SLPs are met, as appropriate.

What are sustainability linked loans?

Unlike green and social loans, sustainable development loans (SLL) provide more flexibility for borrowers by focusing on predefined sustainability targets (SPT) rather than using the proceeds. This allows the proceeds from such loans to be used for general corporate purposes.

The SLLP identifies five main components that must be met in order for a loan to qualify as an SLL. These:

  1. Selection of key performance indicators (KPI);
  2. SPD calibration;
  3. Loan characteristics;
  4. Making report;
  5. Checking.

The borrower should have a clear understanding of how the SPTs it chooses fit into its overall sustainability strategy and should communicate this to lenders. KPIs are what is expected of a borrower in order to achieve sustainable development goals. KPIs also measure SPT, which can be set in line with the UN Sustainable Development Goals.

The SLLP requires the SPTs set by the borrower and lender to be ambitious, meaningful and measurable, aiming to achieve ambitious positive change through incentives. SLLs agree on the terms of the loan to the performance of the borrower in accordance with predefined SPTs agreed and agreed between the borrower and lenders for each transaction. Often, the margin on a qualifying loan agreement is reduced if the borrower meets the SPT threshold.

Providing information regarding the SPT is key. Borrowers are encouraged to publicly disclose this information in their annual and corporate social responsibility reports.

Finally, an independent external review of the borrower’s performance for each SPT for each KPI should be conducted, and the results should be published whenever possible.

Drawing – Project of Kantslersky Lane

There is currently no “market standard” LMA wording for ESG or sustainable loans. In practice, parties develop their own wording, which raises the question of where to start.

Chancery Lane Project (TCLP) is a pro bono initiative that promotes the collaboration of legal professionals in the rewriting of contracts. It aims to provide documentation to support communities and businesses in tackling climate change and achieving net zero carbon emissions. TCLP has published 71 articles that are free and globally available to law firms, corporations and government, for example:

  • SLL issuance manual and checklist;
  • Clauses about cooling plates (template adapted to the climate);
  • Green Regulatory Law Choice Clause;
  • Green Supply Agreement;
  • Supply chain emission metrics map;
  • Green credit starter package.

What’s next? “EU Taxonomy Regulation”

The EU Taxonomy Regulation ((EU) 2020/852) was recently adopted to meet the EU climate and energy targets for 2030 and to achieve the European Green Deal targets. It aims to define clear criteria for defining environmentally sustainable economic activities.

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