Integrating sustainability into financings while maintaining flexibility of ESG metrics
One area of the global investment market which is currently focusing on environmental, social and governance (ESG) elements of transactions is the European leveraged finance space. To this end, the European Leveraged Finance Association (ELFA) and the Loan Market Association (LMA) have worked with their respective committees to create a guide to Sustainability Linked Leveraged Loans. We recommend market participants review this guide as it touches on several important considerations for leveraged financings which want to include ESG related obligations.
We are working with numerous clients across the market to find positive ways to integrate ESG into financings. Sometimes the underlying business has a genuine desire to commit to ESG obligations but acknowledges that they have not yet decided on the right ESG targets to set as at the time the financing is established. To cater for this and other similar scenarios, we have developed an ESG rider which provides for the completion and delivery of an ESG target-setting schedule post-closing. The benefits of the rider include:
- Flexibility: the ESG targets and operative provisions can be amended and tailored on an on-going basis by way of lender consent and we include a range of optionality for clients to consider depending on the nature of the ESG targets.
- Collaboration: all parties are involved in the setting of conditions to the ESG targets, including the use of any external third party experts to help set the targets, or undertake annual ESG target monitoring.
- Simplicity: much like the LMA's LIBOR transition to risk-free rates schedule, the ESG targets and their related provisions are all located in one key operative clause and one easy to use schedule.
While the flexibility, collaboration and simplicity of the rider are to be championed, it is important to be mindful of not representing that the inclusion of this ESG optionality will transform the financing into a "green"/"sustainability-linked"/"ESG" financing. Inclusion of the rider does not, in itself, make the financing an ESG financing: the parties need to use the ESG rider in accordance with its terms. The principle underpinning the rider is that targets and monitoring must be meaningful, and sometimes that will require flexibility in terms of when the targets are set in stone. But equally flexibility should not be used as a way of avoiding meaningful ESG metrics. That is a fine line to tread. It is critical for the integrity of sustainability-linked finance that all market participants work together so as to avoid greenwashing. We have built in protections into the ESG rider to help clients navigate this issue.
Osborne Clarke comment
As well as the relative "newness" of ESG, there is no avoiding how involved and costly the monitoring and reporting obligations can be for an acquired target group given the limited internal resources which need to be upskilled to a sufficient standard and the awareness of the importance of avoiding greenwashing.
We have worked with some of the leading UK mid-market lenders and engaged with their respective ESG teams to craft our ESG rider wording and included it on live transactions. We look forward to working with clients across the market who might be interested in using this helpful tool as they look to adapt to an ESG-focused world.