Structuring ESG Provisions in Finance Transactions: Performance Targets, Key Indicators, Reporting Obligations, Remedies

Description

Sustainability-linked loans, commonly referred to as "ESG-linked loans," incentivize the borrower's commitment to achieving predetermined sustainability performance targets (SPTs) that are measured by using KPIs. When these KPIs are met, the borrower may receive a discount in its loan pricing or other benefits. Lenders can also benefit by building relationships with investors/funds that value ESG investing. Still, the parties must agree on the performance targets and how to measure performance.

When determining SPTs and KPIs, counsel must consider whether the KPIs can be achieved on an incremental basis and whether the KPIs should be revisited periodically to assess their suitability. Counsel must also address reporting requirements; the level of detail and frequency will be based on the SPT's nature. If multiple or complex KPIs are being used, a third-party reporter with knowledge of the complexities involved might be required.

The failure to meet a KPI will typically result in an inability to access the incentivized discount but not an event of default. To preserve ESG incentives, the borrower will want to reinstate the pricing discount at such time as the KPI is satisfied on a subsequent reporting date. Misrepresentation in the reporting related to KPI compliance may trigger an event of default, particularly where there is an element of fault on the borrower.

Sustainability washing occurs when a fund's sustainability credentials are inaccurate, misleading, or exaggerated. To avoid sustainability washing, funds and lenders should ensure that they are transparent. In particular, the SPTs are adequately ambitious and meaningful and are adequately monitored and reported.

Listen as our authoritative panel discusses the nuances of documenting and administering ESG-linked loans.