Charting the course: sustainability in fund finance through LMA's guidelines

The impact on the margins or other direct economic effects may still be debated, but surely we all agree that the pressure coming from the regulator and investors is not going away. For example, SFDR is a set of EU regulations that require asset managers and other financial market participants to publicly disclose ESG information around their investment decisions and financial products, whether or not they are listed as sustainable.

Still, people long for concrete actions in the ESG jungle, not more regulation which keeps on coming our way in any case. While the interest in sustainability-linked loans is increasing also in fund finance, there are still many obstacles to accessing such funding compared to investment grade financing and other sophisticated structures, for example. In overall, the same Sustainability-Linked Loan Principles or the SLLP (published by LMA) also apply to fund finance, but LMA seeks to “provide practical guidance on the application of the SLLP in fund finance transactions by identifying challenges and considerations that may arise and discussing how the SLLP can be best utilized in the fund finance market in a manner consistent with the overarching goals of the SLLP”.

No magic tricks here, but you just don’t want to be late for this party. It is important to understand which KPIs are chosen and how, how to collect data and on which level in the fund structure (sponsor / borrower / investment), but still doing all this by meeting the requirements set by the SLLP.

Here are a few take-aways from the LMA guidelines and real-life examples of the key challenges we have identified so far, with some brief solutions to go with them:

1. Challenge: difficulties in identifying relevant KPIs at the fund level because the borrower often has limited internal operations and resources. Solution: investment level KPIs are increasingly more common in the market as long as the “selection of KPIs, and incorporation of pricing adjustments, must be tied to ambitious sustainability objectives relevant to the borrower’s core business or investment strategy beyond business as usual or mandated legal or regulatory requirements, so as to maintain the integrity of the SLL market”.?
2. Challenge: lack of data from portfolio companies. Solution: A sponsor may be able to refer to the reporting it is providing to its investors, or the historical performance of prior investment funds raised by the same sponsor or other similar investment funds in the market.?
3. Challenge: the verification process by an external reviewer, although required under the SLLP, is getting too expensive. Solution: especially in situations where the fund needs to verify data from a large number of investments, a limited assurance may be a cost-efficient solution, if agreed with the lenders upfront.?
4. Challenge: ESG policy not sophisticated enough. Solution: many sponsors and funds have established and planted ESG processes to their investment policies and portfolio companies’ DNA and are now seeking to link their sustainability targets to their debt financing. Sometimes the fund may simply not yet be ready to enter the SLL world, for example if the investment pipeline is uncertain or the ESG capabilities of the fund or the fund’s portfolio companies are not advanced enough. Then you are set to get back to the drawing board and first establish a sophisticated ESG policy to even get to the point where the fund can determine the relevant SPTs and KPIs.??
5. Challenge: ESG Reporting is often considered too demanding, leading to a bare-minimum mindset with reporting. Solution: While larger funds might be able to carry out more extensive ESG measures and reporting, small to mid-scale funds might find it challenging. By identifying the appropriate KPIs and seeking assistance from ESG service providers or sustainable financing specialists, funds can establish measures and SLLP related requirements at a level that is both reasonable and sufficiently challenging to create an impact.

Try to find the ‘can do’ attitude in all this: this is not a beauty contest. The regulatory shower and the pressure from the financial institutions and other lenders getting the same push from their regulators are not going anywhere. Be active, learn from each other and just keep on doing things instead of letting the regulation eat you for breakfast.

Remember that various ESG service providers can help the sponsor’s and funds’ inhouse team to tackle these issues if they don’t have their own ESG specialists to manage the pressure coming in from both investors and regulators. It is great to see more ambitious SFDR compliant article 9 funds being established (even though the reporting duties are considered heavy compared to e.g. article 8 or 8+ funds), and investors’ monies finding their way into sustainable funds, but we badly need processes being implemented in every company and most importantly even in the not-so-green companies, where the potential and impact are at the greatest.

Want to know more? Contact:

Partner Mariella B?de-Landell, [email protected]

Associate Leo Pajunen, [email protected]?