Towards greater synergies between Sustainability-Linked Loans and the GSS Bond market

The SLLBG are described as being "intended for broad use by the market[1]" and go beyond just providing issuers with guidance concerning the launch of a credible SLLB. Investors will also have better access to information about how to evaluate eligible SLLs, and underwriters will have improved guidance on the facilitation of external reviews and SLLB transactions which preserve market integrity.

 

Given the nature of SLLBs the instrument is mostly designed for credit institutions able to offer SLLs to their borrowers. SLLBs may support further issuance of sustainable debt by financial institutions with notable precedents such as Nordea’s inaugural issuances of SLL bonds in 2022 and 2023[2].

The SLLBG contain four major components for alignment which seek to clarify the approach for issuing SLLBs. These components, which are directly inspired[1] by the Green Bond Principles, Social Bond Principles and Sustainability Bond Guidelines, include (1) Use of Proceeds, (2) Process for SLL Evaluation and Selection, (3) Management of Proceeds, and (4) Reporting:

 

I. Use of Proceeds: One of the key characteristics of an SLLB is that its proceeds are allocated towards eligible SLLs. In accordance with the most recent Sustainability Linked Loan Principles, details about an SLL which is (re)financed by an SLLB must include:

1. the relevance and materiality of selected Key Performance Indicators (KPIs);
2. the calibration and level of ambition of Sustainability Performance Targets (SPTs);
3. and loan characteristics, reporting, and verification.

 

The SLLBG offers two approaches that issuers may use to achieve the appropriate level of transparency, both of which include the involvement of an independent external reviewer:

• Approach 1: Detailed overview of the eligibility criteria for selection of eligible SLLs pertaining to the five core components of the SLLP (including for instance a pre-defined list of eligible KPIs and ambition ranges for associated targets);

 

• Approach 2: Exhaustive high-level list of each eligible SLL (including for instance information on the borrower’s sectors of economic activity, selected KPIs and associated sustainability-performance targets) with independent review carried out at the level of each eligible sustainability-linked loan.

 

II. Process for SLL Evaluation and Selection: This component includes clarifications about the issuer's governance structure, policies and process to monitor overtime the eligible portfolio of SLLs and how it fits into the criteria of the SLLB Framework.

 

III. Management of Proceeds: Like the SLLB Process for SLL Evaluation and Selection, the Management of Proceeds pillar of the SLLBG is similar to the model used in the Principles applicable to other use of proceeds instruments (GSS bonds). The SLLBG gives guidance to the issuer for monitoring the proceeds from the bonds financing SLLs.

 

IV. Reporting: The SLLBG stipulate that issuers should hold readily available and up to date information, which should be reviewed annually throughout the lifetime of the SLLB. While GSS Bonds require an annual report concerning allocation and impact, SLLBs monitor sustainability performance against pre-defined KPIs of the eligible SLL portfolio and strongly suggest transparent performance reporting and the use of an external auditor to verify the allocation of funds.

 

External Reviews should be undertaken under the SLLBG with two types of external reviews emphasized, similarly to the GSS bond Principles:

 

1. Pre-issuance: Issuers should engage with an external reviewer to review their SLLB Framework and its alignment with the four components of the SLLBG under two potential approaches as laid out in the Use of Proceeds section above where:

 

• Under Approach 1 the external reviewer reviews only the SLLB Framework alignment against the SLLBG; and

 

• Under Approach 2 the external reviewer reviews the SLLB Framework alignment against the SLLBG as well as each SLL included in the eligible SLLB portfolio.

 

We expect potential issuers of SLLBs to frequently opt for Approach 1 as part of the external review process of their SLLB Frameworks as many credit institutions may have a significant number of small SLLs on their balance sheet making Approach 2 difficult to implement and potentially costly and time consuming.

 

2. Post-issuance: Issuers should seek external verification of the allocation of SLLBs proceeds to eligible SLLs as part of the reporting to be renewed annually during the lifetime of the SLLBs.

 

In order to align SLLBs to the SLLBG, the four core components should be explained by issuers either in an SLLB Framework and/or in their legal documentation, either or both of which should be readily available to investors. In addition to the role of issuers in disclosing the necessary information about alignment, the SLLBG also encourages external reviewers to provide clarity about their credentials and relevant expertise, in addition to communicating the scope of the review(s) that they have conducted.

Overall, the hope is that the SLLBG can encourage the creation of a new sustainable financing instrument supporting the robustness of Sustainability-Linked Loans. The inclusion of SLLs in eligible loan portfolios for issuance of credible SLLBs could spur discipline among borrowers and lenders and help reduce the use of immaterial KPIs and/or unambitious associated targets (criticisms to which the SLL market has been subjected on several occasions).

 

One key challenge will relate to potential future updates to the Sustainability Linked Loans Principles as the SLLP and SLLBG are to be apprehended in tandem. The SLLPs may face additional modifications in the future which will affect the SLLBG. Staying up to date on the newest modifications and best practices will be essential for ensuring that financial institutions, particularly lending banks, use their influential position to engage borrowers in dialogue to improve their sustainability performance.

 

The appeal of this new type of instrument to bond investors has yet to be demonstrated on a large scale, and the credibility and robustness of potential future SLLB issuances will be essential to ensure the future development of this nascent market. As always with sustainable finance instruments integrity and ambition will be key to the success of this new product.

 

In addition, the very significant growth of the SLL market in recent years indicates financial institutions may already benefit from large exposures to such instruments on their balance sheets that could be leveraged for quick uptake of issuance of SLLB in the market. Nonetheless, we are under the impression that large-scale development of the SLLB market may still require some time following the publication of the SLLBG. Indeed, for credit institutions interested in this new sustainable financing instrument to develop credible SLLB Frameworks and start their SLLB issuance process may entail development of new internal processes (governance, information systems, etc.) for identification, selection and monitoring of SLLs included in the portfolio of loans eligible for SLLB. Speaking from experience, such internal developments usually require large cross-company involvement, notably for the largest financial institutions.