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Green loans are increasingly common in lending markets, enabling borrowers to promote environmental sustainability and also providing a number of ancillary benefits to businesses; including improving reputation and credibility; access to socially conscious investors seeking investments focused on the environment, social and corporate governance; and increased attractiveness for qualified employees who increasingly value environmental considerations.

In the mortgage market, “green” finance is playing an increasingly important role in light of the net zero emissions targets by 2050 set by the EU for member states. These targets are expected to be incorporated into Irish law through the Climate Action and Low Carbon Development (Amendment) Bill 2020. As buildings account for around 40% of energy use and 36% CO2 emissions in the EU, significant reductions in emissions will have to be achieved with regard to buildings in order to achieve these targets.

In this article, we review recent guidance issued by the Loan Market Association (the “LMA”) on applying the principles of green lending (the “Principles”) in the context of loans for real estate renovation projects (“RERF”). “) ( available here) and highlight some notable market trends.

What are green loans?

Green loans are any type of loan instrument made available exclusively to finance or refinance new and / or existing “green projects”. The LMAs have established a non-exhaustive list of indicative categories of green projects, including, but not limited to:

• renewable energy;
• energetic efficiency;
• pollution prevention and control;
• adaptation to climate change;
• green buildings; and
• sustainable management of water and wastewater.

The distinguishing feature of a green loan is that the loan proceeds must be used for a designated green project, which must be adequately described in the borrower’s financial document and relevant marketing materials. Green loans must also comply with the four core components of the Principles, which are discussed in more detail below.

The principles

In 2018, the LMA, in collaboration with the Asia Pacific Loan Market Association and the Loan Syndications & Trading Association, developed the Principles with the aim of establishing a high level framework of industry standards that aim to provide a consistent methodology to be used throughout the Green Loan. financial market. The Principles consist of four fundamental elements:

1. Use of the product;
2. Project evaluation and selection process;
3. Product management; and
4. Reports.

1. Use of the product

As stated above, to be considered a green loan, the proceeds from that loan must be allocated to a green project. In addition, all designated “green projects” should provide clear environmental benefits, which will be assessed and, if possible, quantified, measured and reported by the borrower. A Green Loan can take the form of one or more tranches of a loan facility. In such circumstances, the green tranches should be clearly designated with any proceeds credited to a separate account or tracked by the borrower as appropriate.

As this is an ever-evolving area of ​​debt financing, there is not a single determinant of what currently constitutes a Green Project in the context of the RERF. However, the LMA has stated that it expects RERF projects to result in a significant improvement in energy efficiency and, therefore, a significant reduction in carbon emissions associated with the building or buildings being financed. Examples of such projects include improvements to basic and improved efficiency measures, more environmentally friendly heating and power generation, and the installation of resilience products to protect against flooding and wave surges. heat.

While existing industry standards such as BREEAM and Trustmark can be used to assess the ‘greening’ of a particular project, the LMA has recognized that there are gaps in the data currently available to borrowers and lenders when seek to carry out such evaluations of RERF projects. . However, it is pointed out that there has been a significant increase in the availability of data in this area that can be used to help lenders set thresholds for the post-renovation energy performance of a building or project. .

In determining whether a particular project qualifies as a green project, the LMA has confirmed that lenders can set their own eligibility criteria, rely on external reviews, or make decisions on a case-by-case basis. Borrowers can also produce a “green financing framework” document, setting out the eligible green projects for which the loan proceeds will be applied. While not a requirement under the Principles, the LMA said such documents help increase transparency and avoid potential “green laundering” in an RERF project. “Greenwashing” refers to circumstances in which a specific borrower or project is mistakenly declared to have green credentials (or has exaggerated such claims), thereby compromising the integrity of the loan product and undermining investor confidence. as well as the potential reputational damage caused to the lender as a result.

The use of the proceeds is a key determinant of a green loan. Accordingly, any violation of the provisions relating to the use of the product should be taken seriously and the loan should not be considered “green” from the date of occurrence of such event, subject to any right to repair. Parties should carefully consider whether failure to allocate proceeds from a green loan to a green project will trigger an event of default and subsequent cross-default on outstanding loans.

2. Selection and evaluation of projects

In order to obtain “green” financing, a borrower must send to his lender:

• the environmental sustainability of a project;
• the process by which a project meets the eligibility criteria set by the Principles; and
• the relevant processes used to manage the environmental risks associated with a project.

In the context of funding requests for RERF projects, the above information should be incorporated into the borrower’s overall strategies and policies relating to environmental sustainability. Another useful way to communicate this information to lenders is the “green finance framework” document (mentioned above).

3. Product management

The funds allocated under a green loan must be allocated to a specific bank account or tracked in some other way that ensures that the funds are easily identifiable. When a green loan takes the form of one or more tranches of a loan facility, each “green tranche” should be clearly designated, with the proceeds of the green tranche (s) being credited to a separate account or tracked by the borrower appropriately. .

Although not a requirement, the Principles recommend borrowers to implement an internal governance process to track the allocation of funds used for green projects, thereby ensuring greater compliance in this regard.

In addition, borrowers will often be required to provide commitments and statements in the facility agreement regarding the use of the proceeds for qualifying green projects. These commitments and statements serve to ensure that green loans are, in practice, applied for the purposes for which they are intended, acting as additional protection against “greenwashing”. Failing that, the LMA highlights the following alternative ways to ensure that funds are used for a green project:

• the provision of a statement of the flow of funds as a condition precedent to the drawing, accompanied by a commitment to allocate the proceeds of the loan in accordance with the statement of the flows of funds;
• an obligation to provide invoices to verify the use of funds as a condition precedent to each use; Where
• third party verification of product use.

4. Reports

The LMA said borrowers should ensure that all information relating to the use of loan proceeds is readily available and kept up to date and should be reported at least once a year until funds have been cleared. fully used, and subsequently in the event of hardware upgrades. This should include a list of green projects to which the green loan proceeds have been allocated, including a brief description of the projects, the amounts allocated and their expected impact. This will also allow borrowers to track the relevant funds, thereby ensuring greater compliance with the Principles.

Borrowers may also be required to report to lenders on the performance of the use of the properties concerned (e.g. energy or water consumption) when this has been agreed as a prerequisite for granting a loan. green. All reporting obligations should be clearly spelled out in the RERF project facility agreement and when a borrower has a ‘green finance framework’ in place, it should be updated to include its obligations and commitments to relevant statement.

The LMA stresses the importance of transparency in reporting the impact of green projects and recommends the use of qualitative performance indicators, and if possible, quantitative performance indicators (e.g. energy capacity / production, impact on greenhouse gas emissions, etc.).

Conclusion

The importance of the role that Green Loans will play in the years to come is not in doubt. As Europe aims to meet its net zero emissions targets by 2050, given that almost 75% of buildings in the EU are energy inefficient, substantial investments will be needed in a context of RERF. The LMA recognized that it is unlikely that a single standardized approach could or will be adopted, as there will be substantial differences between the various projects and buildings; however, the Principles as well as the latest LMA guidelines on RERF projects help establish a solid framework as to the criteria for such funding arrangements.

The content of this article is intended to provide a general guide on the subject. Specialist advice should be sought regarding your particular situation.