A sustainability-linked loan (SLL) is a loan instrument that includes guarantees and letters of credit. It is not conditional on the proceeds being used for a particular purpose, but, similar to the sustainability-linked bonds (SLBs), the terms of the loan incentivize the borrower to improve its performance against agreed predetermined environmental, social, and governance (ESG) criteria. The loan can be used for general corporate purposes, but the borrower agrees to have performance assessed across a selection of KPIs and to provide lenders with external verification of performance. The loans, also referred to as sustainability improvement loans or ESG loans, can be linked to a corporation’s overall ESG rating. In these arrangements, interest rates on an SLL can be lowered if a company achieves a higher ESG rating or raised if one or more of its ESG goals are not met.
Most corporations have adopted climate change-related KPIs linked to greenhouse gas emissions because of the ability it gives them to set measurable and quantifiable targets. However, some KPIs have been related to adaptation, including water savings, improvements in conservation and biodiversity, and sustainable farming. The SLL market is expected to play a growing role in adaptation finance, with early targets around water consumption and water use efficiency.
Current or potential adaptation-relevant sector applications:
- crop and food production – including agroforestry; livestock production; fisheries (marine, freshwater, and aquaculture); irrigation;
- ecological services and management – forest management (including afforestation and reforestation); wetlands; ecosystem and biodiversity protection, conservation, and enhancement;
- water supply (infrastructure) – water storage; water harvesting; water management;
- coastal and riverine protection and management – coastal defences or flood protection barriers; river flood protection measures;
- disaster risk reduction – early warning and observation systems;
- energy infrastructure – energy generation (including renewables);
- transport infrastructure;
- other built environment and infrastructure – urban development;
- social infrastructure – education; health facilities; and
- industry and manufacturing.
Additional insights:
- This is an emerging instrument, with the first loan of EUR 1 billion to Philips (a health technology company) in 2017 structured by ING Bank and supported by 15 other banks.
- The SLL market is a growing sector, with nearly USD 1.5 trillion of SLLs outstanding as of December 2022. SLLs are becoming common in the corporate lending market (Finch & Dowse, 2023).
- SLLs have considerable momentum in Europe. Over 80% of the SLL volumes were in European markets in 2019.
Considerations for issuing an SLL:
- Borrower/project-funded SLLs should meet credit and default risk thresholds.
- Loans are not appropriate for all borrowers, especially those that may not be able to take on additional debt.
- Guarantees may be needed for SLLs issued in developing countries to increase lenders’ confidence.
Adapted from the following sources:
Asia Pacific Loan Market Association & Loan Market Association. (2023). Sustainability-linked loan principles: Supporting environmentally and socially sustainable economic activity. https://www.lsta.org/content/sustainability-linked-loan-principles-sllp/
Environmental Finance. (2023, September 11). Adaptation, biodiversity and the SLL market. https://www.environmental-finance.com/content/market-insight/adaptation-biodiversity-and-the-sll-market.html
Finch, S. A., & Dowse, K. (2023, June 28). Sustainability-linked loans: Growth of the sustainable finance market and updated guidance for lenders and borrowers. https://www.blakes.com/insights/bulletins/2023/sustainability-linked-loans-growth-of-the-sustaina