Sustainability-linked Finance

Key Takeaways

  • Committing to sustainability targets can unlock access to cheaper credit.
  • The market for sustainability-linked credit is growing rapidly.
  • Attaching sustainability targets to loans is voluntary now, but this may change.
  • Sustainability-linked loans can be used for any purpose.

The inclusion of sustainability targets in the terms of business loans and other credit options is a growing trend in private corporate lending, as well as in the public sphere. The economic hardship inflicted on many businesses by the COVID-19 pandemic in 2020 could accelerate that growth, as management teams look to borrow to stay afloat and find they have access to money with preferential rates in exchange for meeting sustainability targets. 

These targets can include the reduction of energy consumption and waste, a switch to more sustainable raw materials and social welfare projects. Sustainability-linked loans are a part of a new source of credit referred to as sustainable finance – a catchall term for a credit market dedicated to financing green and social projects, as well as hitting key sustainability targets through debt finance.  

The market for sustainable debt grew by 78% in 2019 to an issuance value of U.S. $465 billion, according to a report by the International Institute for Sustainable Development. A facility called green bonds accounted for more than half, to the tune of $271 billion, up from $182 billion the year before, according to Bloomberg NEF. To date, more than $1 trillion worth of sustainable debt has been issued. According to another market analyst, between $160 billion and 170 billion was provided through a facility known as sustainability-linked loans, an increase of 170% from 2018 to 2019. 

“Sustainable finance generally refers to the process of taking due account of environmental, social and governance considerations when making investment decisions in the financial sector, leading to increased longer-term investments into sustainable economic activities and projects.” 
– European Commission 

Types of Facilities 

There are two main purposes for sustainable debt, according to the Loan Market Association, or LMA, which in cooperation with similar associations in the United States and Asia sets out guidelines for lenders in Europe.  

First is the more established green financing, which first emerged around 2014. This includes bonds, loans, insurance, stock offerings and private equity to generate funds for specific environmentally focused projects, such as renewable energy developments, waste recycling plants or sustainable agribusiness.  

Green loan criteria are set out in the Green Loan Principles, jointly developed in 2018 by the LMA, the Asia Pacific Loan Market Association and the Loan Syndications and Trading Association in the U.S. The Green Bond Principles are set out by the International Capital Market Association. 

The GLPs and GBPs are voluntary guidelines that include verification of proceeds for green projects; project evaluation and selection processes; management of green loan funds separately from other credit lines; and project progress reporting. 

The other purpose is sustainability-linked finance, which also comprises bonds and loans. Sustainability-linked loans, or SLLs, are a newer instrument, with the financial market tracking them from 2019. Since then, they have become one of the fastest-growing sustainable debt products.   

SLLs differ from green finance facilities in that the money does not have to fund green projects but can be used for any general corporate purpose. The borrowing guidelines are set out in the Sustainability-linked Loan Principles, again developed by the three loan associations. These principles include: 

  • measuring the borrower’s existing sustainability status through an environmental, social and governance rating
  • setting “ambitious” and “material” sustainability performance targets, or SPTs
  • reporting on the borrower’s performance of targets
  • and external verification of SPT fulfilment 

SLLs are typically multi-year revolving credit facilities that can include extension clauses if needed. They can be led by one bank, known as a sustainability coordinator, or be backed by a syndicate if the requested funds are sufficiently large.  

Environmental, Social and Corporate Governance 

One of the components of a borrower’s sustainability-linked credit process is often acquiring an environmental, social and corporate governance rating. (See The Investor’s Perspective.) Initially, the purpose of an ESG rating was to assess a company’s sustainability performance, often on behalf of eco-conscious institutional investors, such as asset managers and pension funds, as well as retail investors and consumers. But there is growing interest in ESG ratings from companies looking for lower lending costs with a positive ESG impact, Melissa Menzies, part of the Sustainable Finance Solutions team at Sustainalytics, an ESG ratings agency, told Lubes’n’Greases.  

ESG ratings and ratings agencies play a role in SLLs, where the interest rate of that loan can decrease if the borrower hits a certain sustainability performance target (it can also step up if the target is missed), in two ways. The first is where the borrower works to improve on a third-party ESG rating so that it can access lower interest rates on a loan. The second is where an SPT is a key performance indicator and the lender only requires particular ESG metrics. A rating agency such as Sustainalytics in this case would be asked to verify that those KPIs are material and ambitious in line with market principles.  

Materiality is the intersection between an organization’s desired sustainable development impact and those factors that are important to stakeholders.  

“The rating can be a target in of itself, or it underlies and validates the materiality of key performance indicators,” Menzies said. A borrower’s KPI could be carbon emissions reduction, while the SPT linked to it is a time-bound metric that establishes a target amount. 

Setting Targets 

After the lender assesses the borrower’s sustainability status through the ESG rating, the two parties discuss case-specific SPTs. These can be defined by either party and aligned with the borrower’s corporate social responsibility strategy. The sustainability coordinator or a structuring agent working on behalf of the borrower negotiate the SPTs. 

“Provided that these targets are sufficiently ambitious and that they speak to the fundamental core of the business itself, then sustainability-linked loans would apply,” Gemma Lawrence-Pardew, senior associate director in the legal department of the Loan Market Association, told Lubes’n’Greases.    

SPTs “should be tied to a sustainability improvement in relation to a predetermined performance target benchmark,” recommends the LMA’s SLLP guidelines. “The borrower of a sustainability-linked loan should clearly communicate to its lenders its sustainability objectives, as set out in its corporate social responsibility strategy, and how these align with its proposed SPTs.” 

Typical SPTs are aligned with the United Nations’ 17 Sustainable Development Goals. Table 1 gives some examples of SPTs and ESG activities and how they relate to the UN 17 SDGs. 

Link Between UN 17 SDGs and SPTs 

UN 17 SDG SPT ESG Activity 
13Energy efficiency Improving energy efficiency in the borrower’s facilities and machinery. 
13Greenhouse gas emissions Reducing greenhouse gas emissions related to borrower’s products manufactured or sold or to the production or manufacturing cycle. 
Renewable energy Increasing renewable energy generated or used by the borrower. 
Water consumption Increasing water savings. 
11 Affordable housing Increasing affordable housing developed by the borrower. 
12 Sustainable sourcing Increasing the use of verified sustainable raw materials or supplies. 
Circular economy Increasing recycling or use of recycled raw materials or supplies. 
2, 3, 12, 15 Sustainable farming and food Improving sourcing or production of sustainable products and/or quality products (identified by appropriate labels or certifications). 
14,15 Biodiversity Improving conservation and protection of biodiversity. 
 Global ESG assessment Improving the borrower’s ESG rating and/or achievement of a recognized ESG certification. 

Source: Loan Market Association 

Reporting and Verification 

Key to administering an SLL is reporting the borrower’s performance against the SPTs. The LMA guidelines advise borrowers to make up-to-date records relating to their SPTs, such as ESG ratings, that can be accessed by the lender at least once a year. Records should be reviewed by an external reviewer, which is negotiated and agreed upon by the two parties.  

The LMA also recommends that a borrower should have a third party review its performance against the SPTs. They could include an auditor, environmental consultant or ratings agency, and again are agreed upon by the loan participants.  

Advantages and Drawbacks 

There are several reasons why borrowers choose an SLL or other sustainability-link facility that offset the outlay of an ESG audit and achieving SPTs.  

“A sustainability linked loan acts to incentivize a company on its transitional journey,” Lawrence-Pardew said. “That incentive – although not all of the time – is often pricing linked.”    

Where multiple specific performance targets are set, a pricing matrix may be agreed between parties, whereby the borrower earns a certain reduction in the interest rate depending on which targets, if any, it meets. A corresponding premium is applied if targets are not met.  

“Generally depending on the size of the facility, the interest rate could move between three and ten basis points,” said Menzies. 

Another advantage, Menzies said, is that they are also available to companies that would not normally qualify for sustainable finance facilities like green bonds, given the nature of their business and current investor expectations. 

However, SLLs are currently not regulated as separate facilities and so cannot offer rates that deviate too far from the norm.  

“It’s an option that in my experience is added to existing loan agreements,” said Menzies. 

Another potential drawback can be seen at the ESG ratings stage. They are not yet carried out to universal standard, such as an international financial reporting standard. And while they are not ad hoc, there may be variations in each agency’s methodology and measurement that produce different outcomes. (See The Investor’s Perspective.) 

Certain sustainability targets, such as increased use of recycled materials or reduction in water consumption, are easily  measured. Others, for example, the sustainability of outside suppliers, are more challenging and may require greater auditing depth, which would increase cost.  

ESG ratings are also likely to change as sustainability standards change, and so may need to be revised over the course of these long loan periods.  


Sustainability-linked finance is a growing credit option and compared with other facilities is relatively new. However, for many companies, the economic chaos of 2020 has pushed sustainability down the list of priorities, with those in the lubricant business no exception. This has decelerated growth from the triple-digit expansion seen in 2019.  

“The market will still show an overall increase this year but it won’t be at the rate expected because companies had many other competing priorities to think about,” said Menzies. 

Companies are not compelled to take out SLLs, or any other sustainable instrument, and as yet there are few regulations governing sustainable finance or ESG ratings beyond the principles mentioned above. These include the development of the European Union Taxonomy and some national ESG disclosure requirements in some countries – for example France – and various stock exchange requirements. 

Also on the horizon, the European Commission will include a renewed sustainable finance strategy within the framework of the Green Deal. (See Green Deal.) The strategy’s aim is to raise sustainability on the agenda in the financial industry and strengthen its contribution to the SDGs of carbon neutrality across the bloc by 2030.  

The Green Deal will likely affect almost every economic sector, including the base oils, lubricants and grease industry and all of its ancillary suppliers. And in the current climate, many may need to source credit. 

“There is possibility that at some point in the not-too-distant future all loans will need to incorporate some form of sustainability compliance, without the beneficial pricing being offered,” wrote Eversheds Sutherland, a London-based law firm. 

As pressure mounts from intra-national organizations such as the EU and individual nations for corporate sustainability, these types of sustainable finance products are likely to become more prevalent.