The market guidance for sustainability linked loans has been refreshed and now establishes a clearer outline for market participants. We have outlined below what this refresh means for the NZ debt markets.

Principles for sustainability linked loans

Sustainability linked loans seek to incentivise broader efforts to improve a borrower’s sustainability profile, whereas ‘green loans’ focus on financing a specific green project. The principles for sustainability linked loans were originally published in 2019 by, amongst others, the Asia Pacific Loan Market Association to provide a framework for sustainable financing solutions. While these principles are only voluntary recommended guidelines they were intended to promote the integrity of the sustainable lending market and promote a harmonised approach. Arguably these principles have become the primary guidance for sustainable lending and the refresh establishes a much clearer outline of expectations.

Impact on the proposed mandatory climate reporting regime

This is a timely development as a likely impact of the proposed mandatory climate reporting regime is to significantly raise the profile, and use, of sustainable lending - whether in form of green lending or as sustainability linked lending. We expect lenders will increase the volumes of both and will report on progress annually in their climate reporting. It is important therefore that there is a clear market expectation on what each of these products look like and do so that they can be accurately identified. This will enable market participants to compare disclosures in relation to equivalent products across the market.

The original principles for sustainability linked loans established a high-level set of standards, introducing the requirement for borrowers and lenders to set ambitious and meaningful ‘sustainability performance targets’. Borrowers were to communicate their objectives in accordance with their wider corporate social responsibility strategy, set targets and report against those targets. The requirement for any external review of the strategy, targets and performance was to be negotiated between the commercial parties.

Better standards and expectations

The APLMA standards have now been updated to provide a clear delineation between the selection of key performance indicators and sustainability performance targets. This is a deliberate move away from the aspirational requirement to set ‘ambitious and meaningful targets’ to a more detailed set of expectations. These new requirements describe more fully the standards against which key performance indicators and sustainability targets should be set and detail expectations with regard to benchmarking and disclosures.

Independent and external verification

More importantly, the standards now also require independent and external verification of performance against the targets set, at least, annually. This is a substantial shift from the earlier position which recognises the increasing importance sustainability linked loans will play in the wider loan market going forward and is described as a ‘necessary element’ to preserve the integrity of the sustainability linked loan principles. This requirement, in itself, is a significant step forward in establishing a verification regime for debt products that are categorised as sustainable. This will create more certainty in the market which is designed to ensure that such products will become more accessible. There does remain a question as to who will provide this verification service and who will bear the cost.

Our experts are advising lenders and borrowers on both green and sustainability linked loans, including in relation to development of green star buildings and establishment of forestry assets for the purposes of carbon sequestration.