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4 June, 2019
The growing interest in sustainability in Singapore and all over the world presents borrowers and lenders with an unprecedented opportunity to tap into green finance. When structuring a green loan, green bond or a sustainability linked loan1, borrowers and lenders will need to consider a number of factors, including pricing, purpose, environmental impact, reporting, and alignment with the voluntary standards like Green Bond Principles, Green Loan Principles or Sustainability Linked Loan Principles, as well as a number of legal aspects. We set out in this article some of the key legal considerations to keep in mind when structuring green financing matters.
Introduction
Needless to say, the legal considerations differ across the various green financing products, depending on the nature of the product itself, as well as what is emerging as the market practice for such green products. That is to say, firstly, a green bond and a green loan will differ, in so much as a bond and a loan are fundamentally very different debt instruments, and what the market considers de rigueur in bonds may not be palatable to lenders and borrowers in the context of commercial loans. Secondly, within the context of each product, say a green loan, even though the field of green financing is relatively nascent, there are still certain practices that can be said to be the emergent market practice for such products, which lenders and borrowers, and their respective legal advisers, have come to expect as the norm. We will be discussing such emergent market practice as well, based on our experience advising clients on such deals. However, as this is a developing field where innovation remains very relevant and welcome, such innovation may push the norm one way or the other, based on which way the markets move, consequent to such innovations.
Frequently Asked Questions
Some of the common questions we get asked on the legal considerations when structuring a green finance instrument (be it a green bond, a green loan or a sustainability linked loan) are:
- Is there any increased legal liability in issuing a green finance instrument? What happens if the borrower/issuer cannot meet their “green” purposes/targets?
Generally speaking, a failure to meet certain “green” standards for the green finance instrument poses reputational risks for the issuer/borrower, the underwriter/bank, as well as the credibility of green finance markets as a whole. However, in relation to legal liability, this would depend on the terms of the green finance instrument.
For green bonds, it is usual to see that the application of the funds towards green projects is not drafted as a contractually binding obligation. This may be because issuers, not having received any significant pricing advantage, are wary of incurring additional legal liabilities, and are able to restrict the matters that result in an event of default to only the usual bond provisions. The issuers, however, need to make it clear in the disclosures that the issuance may not always meet certain “green” criteria, and therefore investors who are specifically looking to only invest in green instruments should be made aware of this risk.
For green loans, the purpose clause typically specifies that the loan would be used for certain green assets or projects, and as is usual in loan transactions, the purpose clause is contractually binding on the borrower. Thus, if the borrower fails to use the proceeds for the “green” purpose as contractually agreed, this can trigger an event of default or if the parties have decided that such a default can be cured, it may trigger certain in-built penalties until the borrower has cured such default. The reason behind the differing practices for green bonds and green loans is that the number of parties involved in a loan transaction is usually more limited, making decision-making streamlined, unlike in bonds.
On the other hand, Sustainability Linked Loans are structured on the basis of providing incentives to the borrower to improve their performance on certain predetermined sustainability criteria. For instance, the borrower may be incentivised to pay lower interest rates, if it meets certain predetermined sustainability targets. Where the borrower fails to achieve those targets, the result is simply that those rewards are not applicable to the borrower (in our example, the interest rate payable remains at the higher level), and no events of default are triggered. We have also seen some examples where apart from providing incentives for improvement in sustainability criteria, a lender may also impose a disincentive for a deterioration in sustainability criteria. For instance, if the borrower satisfies certain sustainability goals, the borrower is rewarded with an interest rate that is lower than usual, whereas, if the borrower severely underperforms on sustainability criteria, it is “penalised” with an increased interest rate.
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Are there any green events of default?
Usual covenants or representations concerning compliance with environmental laws, licenses and permits may be included (and any breach thereof may trigger an event of default under the loan or bond documentation). However, over and beyond those, it is not usual to include any specific “green” events of default in both loan and bond documentation. For an analysis on how some of the other “green” clauses in the documentation may or may not trigger events of default, please see paragraph (1) above.
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Can a green bond be added to an MTN programme?
Yes. The documentation for the MTN programme would need to be amended to include the optionality to issue green bonds. Key amendments will include:
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(a) the amendment to the "use of proceeds" section to state that the net proceeds will be used for the identified green purposes;
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(b) the amendment to the "risk factors" section to include a "green" risk element; and
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(c) the inclusion of additional reporting (allocation reporting/impact reporting) requirements.
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Can lawyers’ fees be claimed under the MAS subsidy under the MAS Sustainable Bond Grant Scheme?
Under the MAS Sustainable Bond Grant Scheme, eligible issuers can obtain a grant for 100% of eligible expenses attributable to obtaining an external review for green, social and sustainability bonds, up to S$100, 000 for each qualifying issuance. This scheme is valid from 1 January 2019 to 31 May 2023 (both dates inclusive). Our understanding is that legal fees cannot be claimed under the MAS Sustainable Bond Grant Scheme.
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What are the key factors that differentiate the facility documentation for a green bond and/or green loan from those of a standard bond or loan?
Some of the key differentiating factors are:
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(a) the documentation should identify the "green" purpose for the loan/bond (which should be consistent with the borrower's green finance framework);
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(b) a second opinion on the borrower's green finance framework may be included as a condition precedent document;
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(c) for green bonds, issuers can consider if the "risk factors" section should also include a "green" risk factor in their bond documentation; and
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(d) information and reporting covenants on the green aspects of the loan/bond should be included as an ongoing obligation.
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What are the key factors that differentiate the facility documentation for a sustainability-linked loan from those of a standard loan?
Sustainability-linked loans are loans with a connection to certain environmental, social and governance goals. Sustainability factors commonly feature in sustainability-linked loans by using such factors as a margin ratchet, whereby the margin applicable on the loans would increase or decrease depending on whether the relevant sustainability factors are met. Based on our experience, borrowers may be unwilling to provide additional representations and undertakings on environment, social and governance issues for a sustainability-linked loan, save for the usual representations and undertakings relating to compliance with environmental laws, licenses and permits that are generally included in normal loans.
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How much more expensive is it to document a green bond or green loan in terms of legal fees?
It is difficult to make a blanket statement on this. This would depend on a multitude of factors, including the complexity of the documentation.
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Is there any legal liability if a borrower/issuer is unable to do good impact reporting as per its green financing framework?
Under the LMA/APLMA/ LSTA Green Loan Principles and the ICMA Green Bond Principles, borrowers/ issuers with the ability to monitor achieved impacts are encouraged to include such impact reporting in regular reports. Thus, whether or not these are included in the terms of the green finance framework is for the borrower/issuer to consider. To the extent that these are included into the loan/bond documentation as a binding obligation, a failure to comply can trigger defaults.
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Can one make a loan green after it has been drawn?
The Green Loan Principles and the Green Bond Principles set out certain factors for parties engaging in green finance to consider and are intended to be a set of procedural requirements (with some substantive aspects) to guide parties in the structuring of a green loan (see in particular the process for project evaluation and selection in the Green Loan Principles and the Green Bond Principles). Where these principles have not been contemplated when structuring a loan/bond but are referenced as an afterthought, there is a risk of the loan/bond being perceived negatively by other stakeholders as lacking in “additionality” (ie the factor of channelling capital towards green assets and projects that would not otherwise receive financing) and possibly even “green-washing”. In such circumstances, recasting such loan/bonds as ‘green’ may be counter-productive if the purpose of doing so is to enhance the reputation of the parties involved
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Are there any major legal cases on green bonds/green loans/sustainability linked loans at this stage?
As far as we are aware, there is no major litigation involving issues related to green bonds/green loans/sustainability-linked loans at this point in time.
