Sustainability-linked loans: l cost incentive for ESG action | Hogan Lovells

With restaurants, sport and entertainment venues and museums opening back up to full capacity across the country, refinancings of corporate credit facilities are back in full swing.  And as public companies are kicking off negotiations with their banks, a popular topic is taking advantage of sustainability-linked pricing.  For any ESG (Environmental, Social, and Corporate Governance) conscious company considering a refinancing of, or entering into a new credit facility, sustainability-linked pricing is a tool that should be explored.  

Sustainability-linked pricing in corporate credit facilities is not a new concept to 2021.  Johnson Controls introduced sustainability-linked pricing in its credit facility in 2019 and some of the earliest adopters were in the REIT sector, including HCP and Prologis.  The concept was gaining momentum at the end of 2019 and into the beginning of 2020, but the pandemic and general freeze on credit facility refinancings put a pause on the expansion of sustainability-linked pricing.  Now with corporate credit facility refinancings back and fully active, and making up for the year lost in 2020, sustainability-linked pricing is becoming widely adopted in 2021. 

Sustainability-linked pricing provides a modest pricing incentive, usually a one to two basis point reduction in the interest rate margin, for hitting certain defined sustainability goals.  Thus there is an interest cost savings, albeit relatively minor, for including sustainability-linked pricing, in addition to the value of signalling to investors and the market that ESG efforts are being taken seriously.  The key for making the concept work is having a quantifiable sustainability metric that can be verified and is reported at least annually from which annual target goals can be set.  Ideally such a quantifiable metric aligns with what is already being reported in a company’s annual sustainability report.  This explains why the REIT industry generally has been the quickest to adopt sustainability-linked pricing into their corporate level credit facilities since REITs were already actively tracking and promoting their efforts to improve sustainability across their real estate portfolios.   There are other ways to make the concept work, including engaging a third party to provide a sustainability score, and the concept continues to evolve as it gains popularity.  Sustainability-linked pricing differs from so-called green loans or green bonds because the concept is not tied to use of proceeds from a credit facility being earmarked for a sustainable project or other sustainable uses.  Sustainability-linked pricing can just be incorporated into any credit facility, including a revolving credit facility, regardless of the purpose or use of proceeds for the financing.

While sustainability-linked pricing is a great tool for ESG-minded companies, it may not be for everyone at this stage, particularly if having verifiable, quantitative sustainability metrics are not yet fully developed as a part of the annual sustainability reporting.