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Sustainability-Linked Loans: A Mainstream Phenomenon

Sustainable Finance May 27, 2021
Sustainable Finance May 27, 2021
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The announcement on April 28th of a C$750 million Sustainability-Linked, 5-Year Revolving Credit Facility to Gibson Energy Inc. was a milestone not only for the company and for sustainable finance in Canada, but also for the loan instrument that allows lenders to support clients pursuing a sustainable future.

BMO Capital Markets acted as co-sustainability structuring lead on the Gibson SLL, which made it the first public energy company in North America to fully transition its principal syndicated revolving credit facility into a sustainability-linked revolving credit facility. This came just 15 months after BMO helped Maple Leaf Foods sign the first SLL in Canadian history in December 2019.

SLLs, which attach financial terms to sustainability targets that are negotiated and set between the borrower and lenders, are now one of the fastest growing instruments in the ESG finance sector, accounting for $120 billion of the approximately $700 billion in sustainable debt products issued and structured in 2020.

The Gibson deal introduces a margin adjustment incentive mechanism tied to a commitment to reduce carbon emissions and to increase women’s, as well as racial and ethnic representation in its workforce and on its Board.

“SLLs are quickly becoming mainstream, representing one of the two or three largest growth areas, overall, among sustainable debt products,” says John Uhren, Head, Sustainable Finance, Products and Strategy at BMO Capital Markets. “It’s one of those things where now that the bank loan market has stabilized from a pricing perspective, I think we’ll see a tidal wave of SLLs this year.”

Following is an interview with John, edited for length, on the evolution of the loan instrument in the sustainable debt market, in Canada and the world.

BMO just acted as a “sustainability structuring agent” for the Gibson SLL. Please describe what that means?

The role of the sustainability structuring agent is to work with the borrower to identify the right sustainability targets, or most relevant sustainability KPIs, for purposes of the sustainability-linked loan and, importantly, to structure the loan in accordance with the Sustainability-Linked Loan Principles. The first principle involves selecting sustainability KPIs that align with the borrower’s Corporate Social Responsibility (CSR) strategy. The second principle is around target setting, so the actual KPIs selected are ambitious, pushing the borrower beyond business as usual, which may mean going beyond the public commitments that they have previously made. The third principle is around how the borrower intends to measure against the KPIs and what processes they have in place to measure on a year-by-year basis. And the fourth principle is around review: will they bring in an independent third party to verify their performance against those KPIs on an annual basis and, at a minimum, what are the checks and balances to review their performance and confirm it is as they claim it to be?

There are tangible dollars at stake because if the borrower achieves the KPIs, they get a lower cost of capital in the form of a lower-interest-rate margin, and if they miss the KPIs, they could potentially be paying more interest on the loan.

What were the key components of the Gibson SLL and why are they significant?

The Sustainability-Linked Revolving Credit Facility with Gibson includes an environmental commitment to reduce its Scope 1 and Scope 2 GHG emissions intensity by 15% by 2025, a social requirement to increase the representation of women in the workforce to 40% – 42% and racial and ethnic minority representation in the workforce to 21% – 23% by 2025, and a Governance component, to increase the representation of women on the Board to at least 40%, with at least one member of the Board identifying as a racial or ethnic minority and/or Indigenous by 2025.

These are significant because, in the spirit of SLLs, they build on the company’s sustainability and ESG target milestones and will directly impact its financing costs and force it to stretch for new standards that go beyond previous efforts and goals.

Since BMO helped launch the first SLL in Canadian history with Maple Leaf Foods in December 2019, what has happened in the SLL space, in Canada, North America and the world? Have SLLs gone mainstream?

Yes, SLLs have gone mainstream. Even last year, with headwinds in the bank market (given the onset of the pandemic), there were $120 billion in Sustainability-linked Loans globally. Since the first SLL was launched in Europe in 2017 and expanded to the US in 2018, there’s been significant growth in the market.

You’ve spoken about Europe and Canada; what about in the US? Are SLL’s growing faster there than in Canada?

Yes, in the US, there have been several SLLs just in the last few months, and they number in the low 30s over the past year, so they really are growing rapidly in the United States. They are a very flexible vehicle for a borrower to put in place on top of an existing borrowing facility where it aligns with their overall sustainability strategy, so it’s often a no-brainer for the borrower.

Canadian banks and most major US banks that have made meaningful sustainable finance commitments have proven themselves to be more than happy to bring these solutions to their clients – and vice versa, with clients, increasingly asking for the structure.

Globally speaking, what are the sectors that are embracing SLLs? Are there any limitations?

There are no limitations whatsoever. Traditionally in the sustainable debt market – think labelled green bonds, social bonds, sustainability bonds – there are certain sectors that in general struggled to tap the sustainable bond market by virtue of the industry in which they operate. So, for example, companies in industries like fossil fuels or mining may not have access to the sustainable debt market even if they’re best in class within that sector and have sufficient green or social projects. With a sustainability-linked loan, one of the nice features of it is that it is available to companies and borrowers in every sector. It’s sector agnostic, so any company that has a sustainability strategy is eligible.

Can we expect more and even bigger deals in the near future? Is this Gibson deal large?

We’ve seen Canadian SLLs ranging from $750mm to $2bn, but in the US we’ve seen SLLs reaching US$10bn. The sky really is the limit as it relates to SLLs as more and more borrowers are interested in aligning their debt instruments with their overall ESG strategy.

Turning to the banking perspective, has the Canadian/North American Financial Services industry fully embraced SLLs? How can we quantify that?

I would say that in Canada, yes, they have, and I can say that with confidence now having been the sustainability structuring agent on three SLLs and having been involved in three others. Having led them and having had conversations with the lending groups, which often include a variety of Canadian and American lenders, it seems they have fully embraced Sustainability Linked Loans.

What’s changed since the first SLL was launched in Canada?

What I’ve seen from December 2019 through to the conversations that I am currently having with lenders is that there is a lot more comfort around the structure, and they are asking the right types of questions to ensure the SLL has been properly structured. Questions around how KPIs were selected, alignment with borrower’s CSR strategy, what level of oversight and review exists, etc.

So, I think the level of sophistication has greatly increased. While in 2019, the product was new, and lenders were unfamiliar, now we are having conversations with product experts that are pushing to structure the product as well as possible. So, I find that encouraging, and to me, it signals that there’s a readiness to continue to see these products.

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John Uhren Head, Sustainable Finance, Products and Strategy

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