Updating industry bodies' green loan principles and guidance is usually a routine exercise but a recent revamp raised complex legal questions around applying regional taxonomies on a global basis as more countries create their own definitions of sustainability.
The Loan Market Association in Europe, the Loan Syndications and Trading Association in the US, and the Asia Pacific Loan Market Association discussed whether or not to include the "do no significant harm" principle of the European Union’s groundbreaking green Taxonomy in their February update to the GLPs.
As the GLPs and guidance are designed to apply globally, the three primary loan associations decided not to include an explicit reference to "do no significant harm" language in favour of a broader, and potentially weaker, definition.
The EU’s green Taxonomy was the first classification system to create a list of environmentally sustainable economic activities and came into effect in July 2020, but other regions are creating their own taxonomies rather than committing to its tight definitions.
The wording of "do no significant harm" raised issues in certain legal jurisdictions, including the US, around due diligence and whether borrowers would be able to provide impact assessments to confirm that deals met such a broad definition, sources said.
"Because this is a multi-jurisdictional framework, we were mindful to be sure that we were not inadvertently requiring non-EU participants to comply with an EU standard when it is not applicable to them," said Tess Virmani, an executive vice-president at the LSTA.
Rather than including the "do no significant harm" language, the update to the GLPs issued in mid-February added social risk to the categories that need to be considered when projects are selected. It also included new guidance that borrowers should try to mitigate any adverse environmental and social impacts of proposed projects.
Law firm Meyer Brown described the changes made in the mid-February update as "relatively modest", while other market participants said that the update lacked detail.
"The principles have enough of a framework to be guidance, but given the market is evolving are avoiding being too prescriptive,” said Sukhvir Basran, co-head of law firm Hogan Lovells' impact financing and investing unit.
“The associations are leaving taxonomy-aligned financings to be analysed on a case-by-case basis between the client and law firm. Some of the technical screening criteria remain to be confirmed," she added.
Companies are already using the new GLP and guidance. Shipping firm Hapag-Lloyd completed two deals in February – a US$417m loan from a syndicate of 11 banks backed by South Korea's export credit agency K-SURE and a US$472m lease financing structured by ICBC Leasing.
An independent second-party opinion was obtained from DNV GL to verify that both financings fulfilled the GLPs, which were originally created in 2018 to define when loans can be called "green".
Taxonomies collide
While the GLP wording that was finally selected is similar to that used in China's and Canada’s taxonomies, the issue of aligning standards across different legal jurisdictions that bedevils sustainable finance is set to continue as more countries create taxonomies.
"I would imagine as more taxonomies proliferate then there will be alignment exercises to harmonise those where need be," Virmani said.
Singapore asked for feedback on a new green taxonomy in January, and the UK said in November that it will create a new post-Brexit taxonomy when it announced its upcoming green bond issue.
"Clearly, we're going to have different regimes and taxonomies, there's no question there. It's going to be complicated," Basran said.