In this article we give some insights in relation to ESG considerations in loan transactions as well as the technological aspects that come along with it.
Now more than ever before, investors lending money to fund managers want ESG to be on the agenda for discussions prior to committing funds. A new study* from the Alternative Credit Union and global law firm Allen & Overy found that 74% of fund managers are now integrating ESG into their investment processes. We are now seeing a common pattern towards greener investing, measured by ESG-driven metrics and in some cases, lenders have to agree these targets with the Limited Partners (LP).
ESG and the Loan Agent
Fund managers, and lenders in general, are increasingly conscious of ESG concerns when it comes to deploying funds. We have all seen how the interest in ESG considerations has gathered pace and momentum over the last couple of years to such an extent that we are also seeing an increasing number of requests being placed on borrowers to provide additional information at different stages of the investment process.
It is now common practice for borrowers to include ESG considerations when submitting their initial request for a loan facility to the Lender’s Credit Committee. In addition, during the lifetime of the loan, there is also an increasing number of deliverables from borrowers to include reports, facts and statistics in support of their ESG and Sustainable Finance Disclosure Regulation (SFDR) compliance.
The Loan Market Association has been very much involved over the last couple of years in trying to find a common form of loan agreement that would standardise ESG disclosures, and we recently saw the publication of the Sustainability Linked Loan Principles (SLLP), which is a new concept of funding that enables lenders to incentivise the sustainability performance of the borrower.
The most common form is where the terms and conditions of a sustainability linked loan are associated to pre-determined KPIs and provide financial incentives to the borrowers for satisfying the eligibility criteria. For example, the margin applicable to the loan is reduced if the threshold results as disclosed in the compliance certificate are met, or further funding will be available to the borrower if KPIs are satisfied. In these situations, the loan agent’s role will be pivotal as they will act as a conduit in terms of diarising the delivery of the reports and follow up with any queries that lenders might have in order to help them meet their obligations towards regulators and their own investors.
Systems adaptability and technological challenge
Loan Agent technology systems are going to have to evolve in order to keep up with these evolving ESG requirements; no finance parties to a transaction can nowadays survive by using the same systems they were using a few years back.
Whether it is the borrower, the lender or even the Loan Agent, improvements to systems will need to be made and we are seeing an increasing use of tech tools from a loan documentation perspective in order to improve efficiency and accuracy. How will the borrower take advantage of SLLP and provide the relevant supporting facts and figures? How will the lender record and analyse the results in an informative way for their own investors?
This all affects the already tight margin within which each party to the transaction is operating. Whilst acting as Loan Agent is widely regarded as an art, it is fair to say that a certain amount of technology is essential to support the Loan Agent’s work, so we expect a substantial element of technological change and maybe even the use of Artificial Intelligence in the very near future in order for Loan Agents to be able to keep pace with market trends.
* source: allenovery.com