Sustainability-Linked Loan Principles in real estate finance and real estate development finance transactions
The LMA has recently launched new guidance on the application of the LMA's Sustainability-Linked Loan Principles ("SLLPs") in Real Estate Finance and Real Estate Development Finance ("REF").1
This guidance is the result of recent work carried out by the LMA with its REF and sustainable lending working parties and follows various roundtable discussions with market participants (one of which Stephenson Harwood representatives attended). It is intended to support the development and integrity of sustainability-linked lending in the REF market. The LMA guidance expressly acknowledges that there is still significant potential for further growth of sustainability-linked loans in the REF and development finance contexts. The guidance attributes this to, amongst other things, the urgent need to decarbonise existing building stock to meet global climate targets, to improve the sustainability of construction methods and materials, and to tackle the shortage of affordable housing globally.
Following the launch of the SLLPs by the LMA in 2019, sustainability-linked loans became increasingly popular in the syndicated loans market. Volumes of sustainability-linked loans started to outstrip those of the LMA's "green loan" product. However, this explosion of popularity for sustainability-linked loans has not yet, to date, extended to the REF market. It remains far more common to see a green loan used in the REF market, than a sustainability-linked loan.
While some sustainability-linked lending has already been seen by way of funding to real estate investment trusts ("REITs") and in relation to social housing, there remain some fundamental and legitimate reasons for the slower uptake of the sustainability-linked loan in the REF market. These are identified in the LMA's new guidance:
- Development finance transactions already tend to lend themselves well to a green loan. It will commonly be possible to identify a development project (or an element of that project) as being "green" and complying (in full or part) with the LMA's Green Loan Principles ("GLPs").
- REF lending is usually asset-based and, where there is a single property or development being financed, it is commonly owned by a special purpose vehicle ("SPV") with no trading history. An SPV borrower is unlikely to have an existing sustainability strategy or access to relevant historical environmental, social and governance ("ESG") data.If there is no history to look to, or measure forward from, this can cause challenges with a sustainability-linked loan under which a borrower's performance is measured using pre-defined sustainability performance targets ("SPTs"), as measured by pre-defined key performance indicators ("KPIs").As the LMA guidance acknowledges, this tends to be less of a problem where (i) there is a portfolio of properties to be financed, (ii) capex is required to finance retrofit works or (iii) the property being financed is an operating asset.
- Against the security of the underlying property, a REF investment lender will usually provide finance to a borrower who will let out the relevant property to one or more tenants, relying on the rental income to service the debt.While there is the capacity for property owners to require their tenants to adhere to green/sustainability-linked principles via provisions in the underlying lease, a property owner will often not have de facto control over the activities of a tenant occupying the property. Consequently, a borrower may not wish to grapple with targets and measures related to the underlying property being financed, the satisfaction of which could, in reality, be under the day-to-day control of another party. This is not, of course, a barrier to a borrower and lender agreeing sustainability targets which are not directly linked to the underlying secured property, but for the reasons set about above, the more "corporate" sustainability-linked KPIs and SPTs are likely to be more challenging for SPV borrowers/property owners.
- The LMA guidance acknowledges that there are still divergences within the market in relation to what is considered "doing enough" in terms of improving sustainability performance in the REF and development finance contexts.This can lead to concerns around greenwashing, which can cause reputational damage for both borrowers and lenders.
The LMA guidance builds on the existing SLLPs2 and related guidance3, but adds a REF-specific gloss on:
- the roles of the parties involved in a sustainability-linked loan in ensuring the transparency and integrity of the sustainability-linked loan product;
- selection and disclosure of KPIs (with illustrative examples tailored to the REF context);
- calibration of SPTs;
- reporting and verification; and
- documentation considerations.
Nothing in the LMA's guidance can fully resolve all the challenges inherent in using sustainability-linked loans for REF transactions. However, as we have observed in a previous article, even where a REF project lends itself well to a green loan, it may not always be possible for a transaction to satisfy all the requirements of the LMA's GLPs. With accusations of greenwashing an ever-present concern, wherever possible lenders will wish to strive to achieve the "gold standard" of compliance with relevant LMA principles. This new LMA guidance may help lenders to see potential avenues for re-configuring a green loan proposition which doesn't quite comply with all the GLP requirements, to a loan which complies with the requirements of the LMA's SLLPs instead.