Going green – Application of the LMA Green Loan Principles in real estate finance
The Loan Market Association (LMA) recently issued guidance on the practical application of the Green Loan Principles in the real estate finance context. The guidance focuses on what borrowers and lenders should consider when using green loans for investment in green buildings and the retrofit of existing buildings.
We have summarised below some key points to consider if you are a borrower or lender entering into real estate finance transactions using green loans:
A reminder of the importance of use of proceeds
Borrowers should be reminded that green loans are distinctly different from sustainability-linked loans in regards to the use of proceeds. For green loans, the proceeds must be used exclusively for green projects.
What qualifies as a 'green project'?
At the moment there is no market definition of 'green projects' available to market participants. Therefore lenders need to take responsibility for setting their own internal standards or 'eligibility criteria' for determining what they classify as green projects in the real estate context. Lenders should ensure their criteria are clearly agreed and documented with the borrower prior to completion which can help to prevent accusations of 'greenwashing'.
Borrowers can also take the lead in mitigating against the risk of greenwashing by documenting the eligible green projects towards which they intend to apply green loan funds. If the borrower does not have a designated eligible green project at the time of entering into the loan, a solution could be to designate a revolving credit facility as a green loan. If this option is used, it is important that the eligibility category (or categories) of green projects for which the proceeds can be used towards are sufficiently identifiable in the loan documentation.
In the real estate retrofit context, the guidance provides a helpful description of retrofit projects that qualify as green projects. Essentially retrofit projects should result in a material improvement in the energy efficiency of, and result in a material reduction in the carbon emissions associated with, the building or portfolio of buildings being funded.
Consequences of committing a "green breach"
Parties need to think seriously about the consequences of committing a 'green breach' under a green loan. In particular parties may wish to consider whether any breach of the use of proceeds provision should trigger an event of default and a subsequent cross-default across outstanding loans.
Measuring "greenness" of buildings
Many green loans are used to develop and invest in green buildings. As with the definition of 'green projects', there is still no universal standard as to what can be classified as a 'green building'. The guidance advises lenders to use external standards and certifications instead to measure the 'greenness' of buildings. The guidance on this point may assist lenders with their process of determining whether investment in certain real estate or retrofit projects can qualify as green projects.
Lenders should by wary that buildings which may be classified as green at the beginning of a loan term may cease to meet the requirements for being green during the loan term. It would be prudent to agree with the borrower certain mechanisms for assessing the eligibility of a particular property throughout the life of the loan term where the allocated funds are intended to be drawn after the completion. These mechanisms would then be built into the loan documentation.
Parties should consider whether funds could be advanced by way of green and non-green tranches. This is particularly applicable to situations where only certain properties within the wider portfolio of properties qualify as green projects, eligible for funding via a green loan. The different labelled tranches can ensure that funds are appropriately tracked to their use.
Generally reporting obligations will depend on the size and nature of the transaction and the borrower. Best practice indicates that borrowers should aim to report at least annually on the use of proceeds until the loan is fully drawn, and as necessary thereafter in the event of any material developments.