Many businesses have started focusing on environmental, sustainability, and governance (ESG) practices now that green financing has become mainstream. However, there are still companies that have been able to catch up quickly. There isn’t currently a legal requirement for businesses to set ESG-related goals.
The two terms are sometimes blended with an increased focus on ‘green loans’ and ‘sustainability-linked loans.’ Let’s look at the difference between green loans and sustainability-linked loans.
Green loan
A green loan is any loan instrument made solely to finance or refinance, whether in whole or in existing eligible green projects. ‘green’ and ‘green projects’ vary based on sector and geography. The example of eligibility categories shared in the LMA’s Green Loan Principles (GLP) includes energy efficiency, renewable energy, climate change adaptation, and green buildings that follow regional, national, or internationally recognized standards or certifications.
The GLP provided a framework for green loans created on the following four core components:
- Use of proceeds: The loan proceeds for a green loan needs to be utilized for green projects. All green projects must provide well-defined environmental benefits which will be evaluated, quantified, measured, and reported.
- Process for project assessment and selection: Borrowers need to communicate to lenders the environmental sustainability objectives, determine the eligibility of the GLP categories, and handle environmental hazards related to any proposed project.
- Management of proceeds: The green loan proceeds must be tracked effectively to maintain transparency and distribution of funds towards green projects.
- Reporting: Borrowers must make and keep up-to-date data/information regarding the utilization of proceeds, including the list of the green projects where the green loan proceeds have been assigned.
One example of green financing may include a provider funding renewable energy updates for housing stock or leasing.
Sustainability-linked loans
A sustainability-linked loan (SLL) is any loan instrument or contingent facility (e.g., bonding line, letter of credit, guarantee line) that incentivizes the borrower to accomplish ambitious, prearranged sustainability objectives.
A borrower’s sustainability performance is determined through sustainability targets (SPTs), including external ratings, key performance indicators, and equivalent metrics that assess improvements in the borrower’s sustainability profile.
The definitions of ‘sustainable’ and ‘sustainability’ vary based on geography and sector; examples of usual improvements that an SPT in a specific category might seek to quantify are contained in the LMA Sustainability Linked Loan Principles, which include renewable energy, sustainable sourcing, affordable housing, and energy efficiency.
The key difference
The fundamental element of differentiation is how the loan proceeds for the green financing are utilized; however, the core components of the Green Loan Principles must also be followed. The focus of the Sustainability Linked Loan Principles is giving incentives for the borrower’s efforts to expand its sustainability profile via alignment of loan terms to the borrower’s performance against SPTs. The use of proceeds isn’t a critical determining factor in categorizing an SLL.
Both structures have been proven to be practical tools in sustainable finance, and each is becoming a mainstream green financing tool in its own right. Your next move is to find a banking partner to provide green financing, after which you can take actual, practical steps to make your business sustainable.
Story by Umair Asif
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