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Finance

How to avoid risk when providing Green Finance

How to avoid risk when providing Green Finance 1

By John O’Donovan, Partner and head of Banking & Finance, and Ozan Zorba, Associate, both at law firm Harold Benjamin

The need to become more sustainable and environmentally friendly is on the forefront of everyone’s minds.  Following COP26 towards the end of 2021, the Chancellor announced plans for the UK to become the world’s first net zero financial centre. For years prior to this, the banking industry was already providing “Green Finance” to fintechs, developers and many other start-ups with more and more businesses looking to integrate environmental, social and governance (ESG) criteria into their investment decisions.

However, when offering Green Finance products to developers or other businesses, Banks will need to be more vigilant than ever when conducting their due diligence on the prospective borrower, who will more than likely look to take advantage of the better rates that green products have to offer.

There are various sustainable finance products that have been made available for financing Green Projects. Examples of projects where Green Finance could be utilised are; development of a “green” building that runs on renewable energy, refurbishing buildings/offices to improve the energy efficiency, installing solar panels, acquiring green transport such as electric cars, sustainable food, agriculture and forestry, waste management and greenhouse gas emission reduction.

However, it is important to note that with the oversubscription of green loans, investors and stakeholders are placing greater scrutiny on such loans to ensure they do not fall foul of any ‘greenwashing’. Greenwashing can arise where; the green purpose of the loan comes into question, how the green finance will be maintained and tracked, how the targets are evaluated and verified, and what the consequences a breach of a green loan will amount to.

In March 2018 the Loan Market Association (LMA) alongside the Asia Pacific Loan Market Association (APLMA) and the Loan Syndications and Trading Association (LSTA) published the Green Loan Principles (GLP) having recognised the developing notion of Green Finance/Green Projects. The GLP sets out the framework and guidelines for practitioners to adopt when advising on the wholesale green market. The GLP has four core components to which a loan, if considered to be green, it must comply with: (i) Use of Proceeds, (ii) Process for Project Evaluation and Selection, (iii) Management of Proceeds and (iv) Reporting.

The Green Finance market continues to develop, however, no market standard facility agreements incorporate the GLP. When drafting a facility agreement for Green Finance, the purpose clause will be significant as this will need to refer to the specific Green Project being financed/re-financed. This will cover the Use of Proceeds core component of the GLP.

Taking into consideration the Process for Project Evaluation and Selection, the inclusion of conditions precedent, representations, warranties and undertaking clauses within the facility agreement will ensure that the borrower adheres to its environmental sustainability objectives. This should provide some comfort to the Bank that the borrower intends to use the facility for such Green Projects. Banks should also look to impose a disclosure obligation on the borrower to disclose their green standards or certifications. Drafting the aforementioned clauses within a facility agreement will also allow the borrower to communicate its intentions of their Green Project and will allow the Bank to assess its eligibility of Green Finance.

Banks will want to see evidence that the proceeds of the Green Finance to the borrower will be managed accordingly (Management of Proceeds). Banks can include stipulations within the facility agreement setting out where the Green Loan should be paid into (a specific account) or incorporate another method of tracking such facility. The inclusion of representations together with Green Loan undertakings can also be negotiated. Instead of an event of default clause being incorporated within the facility agreement, Banks can declassify the Green Loan if the borrower fails to comply with the necessary undertakings or representations, thereby allowing the facility to carry on but at a normal interest rate, rather than Green Loan rates.

Reporting can be included in a number of ways. Banks can include a reporting provision within either the representations, warranties or undertakings clause, which can set out the requirement for the borrower to report on the use of the proceeds. Practitioners can incorporate this by specifying the information that is required (as set out by the Bank) and the frequency in which the borrower will have to provide such information. Banks may want the borrower to provide such information in a form of certificate, such certificate can be negotiated and set out in a schedule to the facility agreement.

When taking into consideration the drafting elements of a Green Loan, practitioners may want to consider using The Chancery Lane Project, which is a collaboration of lawyers across multiple jurisdictions and disciplines looking to tackle and address the issues of climate change within contracts and laws. This will hopefully create standard clauses and draft provisions to incorporate into contracts such as facility agreements.

Banks should always carry out the necessary due diligence on their prospective borrowers. By incorporating the core components of the GLP within facility agreements and making sure the borrower provides/discloses the necessary information or certifications before and during the term should provide more comfort to Banks when providing Green Finance for Green Projects.

Having clear, appropriate and well-drafted facility agreements in place is essential for providing Green Finance. By drafting the appropriate clauses to fund a particular Green Project, Banks will need to have bespoke clauses and deliverables in place for each facility. Banks will also require clear processes in place to track the borrower’s progress on the Green Project the Bank is funding, possibly by agreeing to provide funds to a specific Green Account and/or by providing Green Tranches on particular milestones on a Green Project.

Given the rise and focus of the ESG Criteria within society in general, investors and developers will look to make investments within projects that adopt the ESG criteria. These standards and requirements will only continue to develop over the years in order to reach our goal of becoming net-zero. Banks may also be offered further incentives to provide Green Finance to borrowers.

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