Sustainability Linked Loans are good business
The world is facing, what seems to be, an ever-increasing list of environmental, social and governance (ESG) challenges. From climate change to modern slavery to rapid biodiversity loss, business can no longer escape the role that it plays in accelerating these challenges. Likewise, the finance industry is increasingly needing to navigate exposure to a growing list of ESG risks.
Sustainable investing allows investors to not only reduce their risk exposure but put their capital to work in a way that positively and actively influences business and society to move towards more sustainable solutions.
Sustainability Linked Loans (SLLs) are one of the mechanisms with which investors can do just this. SLLs allow investors to support sustainable development by fostering environmental and socially sustainable economic activities. SLLs are performance-based loans whereby the loan is linked to specific borrower-agreed sustainability performance targets. Borrowers must commit to sustainability performance targets to access the capital or to receive a reduction in the loan interest rate.
Sustainability Linked Loans are increasing in popularity
Sustainable investing is on the increase for various reasons, not least because people are becoming more interested in investing in a way that aligns with their values and allows them to contribute to making a positive change in the world (as well as generate financial returns). Millennials make up the majority of this new wave of investors, which means this trend is likely to only increase.
Financial institutes are following this demand and increasing sustainable products on offer. Sustainable investing products can range from “doing no harm” through to products that seize on the opportunities provided by innovations in clean water and sanitation, energy generation, improved health care, and more efficient transportation. In fact, this positive screening of ESG opportunities has seen investments that generate financial performance that is, at a minimum, in line with market benchmarks.
According to the LSTA, the SLL market was $681 billion in 2021. This presented a 275% increase from 2020, when green lending and SLLs raised $181.7 billion. This indicates that the market for SLLs is increasingly more assertive and that companies are becoming intentional in their sustainability strategies. The linking of loan interest to agreed sustainability targets shows that companies are becoming aware of the benefits of improving their short to medium-term sustainability practices.
Reporting on Sustainability Performance Targets is required
SLLs usually require some form of reporting from the borrower to the lender. Reporting of SLLs is guided by the Sustainability Linked Loans Principles (SLLP). The SLLP was developed by the LSTA, the Loan Market Association (LMA) and the Asia Pacific Loan Market Association (APLMA). The Sustainability Performance Targets (SPTs) of SLLs are measured through a selection of Key Performance Indicators (KPIs) that are material to the issuer’s business sustainability strategy. The SPTs determine the borrower’s commitment level and must be ambitious and well calibrated. The SLLPs strongly recommend an external review of the borrower’s performance against its SPTs and for the outcome of such reviews to be made publicly available where possible.
A case study of Kathmandu
ANZ Bank New Zealand partnered with KMD Brands (formally Kathmandu Holdings Limited) to establish the largest syndicated SLL in New Zealand valued at $100 million in May 2021. The SLL stipulates that KMD Brands’ targets be measured against specific sustainability performance targets. KMD Brands’ borrowing costs would change depending on its performance against these predetermined targets.
LRQA (formerly ELEVATE Ltd) was engaged by KMD Brands (which consists of three iconic brands: Kathmandu, Rip Curl and Oboz) to provide a third-party independent review of its performance against Sustainability Performance Target 4 (SPT 4) for the year 2022. SPT4 requires that 100% of KMD Brands Tier 1 suppliers and at least one Tier 2 supplier for each individual brand, is accountable to the KMD Code of Conduct and can supply evidence that it is being monitored for compliance with the Code of Conduct. This includes a social audit at factory level at least once every two-years. ELEVATE’s activities on the project included a review of KMD Brands’ detailed provisions of SPT4, supplier data management systems, audit schemes and monitoring tools.
LRQA’s (formerly ELEVATE Ltd) review marked a milestone for the company as 2022 was their first year of verification, demonstrating their progress in complying with the requirements of the SLL agreement with ANZ Bank New Zealand.
Gary Shaw, KMD Brands Social Impact Manager, said the review was “a fantastic example of collaboration and assurance supported by independent verification”. The review fulfilled Kathmandu’s needs and showed the company’s efforts and progress since the inception of the SLL.
How can LRQA (formerly ELEVATE Ltd) support you?
LRQA (formerly ELEVATE Ltd) has extensive experience in assessing and reviewing sustainability quantitative and qualitative information. LRQA (formerly ELEVATE Ltd) offers verification and assurance services that enhance the credibility of the reported sustainability information, which can be used to fulfil regulatory and financial responsibilities, as well as to be used internally to make informed business decisions. LRQA (formerly ELEVATE Ltd) is an accredited AA1000 Assurance Standard (AA1000AS) v3 provider and can support your sustainability reporting and assurance journey.