ESG: Evolving from emerging trend to central strategy

Fried Frank partners Kathryn Cecil and Jons Lehmann look at sustainability-linked products, including ESG-linked subscription lines, and outline some considerations for negotiating them.

Despite the economic turbulence caused by the covid-19 pandemic, growth in sustainable, socially and environmentally-responsible investment – and the development of bespoke financing products to promote such activity – looks set to continue.

In response to investor demand, increasing numbers of asset managers are establishing ESG-focused funds. This, in turn, is a major factor driving demand for ESG-themed financing products – from leveraged loans for portfolio businesses to fund-level financings.

Given the rise of ESG-focused investments and debt instruments, methods for measuring ESG credentials and the development of a framework for reporting requirements based on a standardized set of key performance indicators is attracting increased attention.

Kathryn Cecil

Growing popularity of sustainability-linked debt products

As ESG-compliant investments become more prevalent, the loan market is developing a roster of financing products that include ESG-linked criteria for borrowers to meet. According to BloombergNEF, issuance of sustainability-linked loans approached almost $500 billion in 2019, more than double the level two years earlier.

Green loans or bonds are debt instruments where the proceeds are used exclusively to finance or re-finance green projects; for example, building a solar energy plant or investing in other renewable energy technologies. By contrast, sustainability-linked loans do not require loan proceeds to be applied towards any specific purpose; instead, they include economic incentives – usually related to pricing – based on the borrower’s compliance with certain ESG-linked criteria.

Unsurprisingly, given their broader application, sustainability-linked loans are growing in popularity compared to green loans. In credit facilities in particular, a margin adjustment – either a discount if certain ESG-related performance criteria are met or a premium if the criteria are not met – may be used to incentivize the borrower to meet certain ESG-related thresholds. In 2019, Fried Frank advised MASMOVIL in its financing to become the first European borrower to place a leveraged loan deal incorporating a margin ratchet on the undrawn facilities based on an ESG rating as part of its €1.7 billion debt package.

ESG criteria also feature in fund finance facilities, including, for example, EQT’s recently syndicated €2.3 billion subscription credit facility. According to an EQT press release, the facility’s interest rate is determined by a ratchet mechanism based on the average compliance across EQT’s portfolio companies in respect of gender equality on management boards and renewable energy transition. Compliance will be monitored using measurable KPIs reported quarterly and tested annually.

Practical considerations for funds when negotiating sustainability-linked financings

While sustainability-linked financings are increasing in size and prevalence, clear market norms have not yet emerged. Borrowers and lenders still negotiate ESG-related terms on a case-by-case basis, although we expect this to change as the market evolves and advisors (including lawyers) can facilitate guiding clients through some of the key issues arising in ESG-linked financing transactions.

When structuring an ESG-linked financing, well-advised funds may consider some of the following:

  • What are the fund’s current ESG policies and how are these reported to investors?
  • Should ESG criteria be measured at parent fund level or at portfolio company level?
  • Would it be appropriate for funds to align their ESG criteria with the ESG profile of their target investor base?
  • Who should verify whether funds are satisfying ESG-related obligations in debt documentation? Will lenders require third-party accreditation and, if so, should borrowers cover this additional cost?


Jons Lehmann

The search for consensus on a common lexicon and framework for ESG standards


A challenge for ESG initiatives is the search for consensus on a consistent set of global principles and reporting standards – an IFRS equivalent for the ESG world. A standardized approach would not only enable both investors in ESG funds and lenders of ESG-linked facilities to formulate consistent standards that can be applied across industries, but also enhance funds’ ability to market ESG investments by increasing investors’ understanding and trust in such products by creating comparable standards.

Substantial progress has been made at a supranational level, as well as sector and industry level, to promote green and sustainability developments. To promote consistency in the finance markets, the Loan Market Association published its Green Loan Principles and Sustainability Linked Principles (along with recent guidance on these principles) to provide a standardized set of objectives for borrowers and lenders when negotiating green or sustainability-linked facilities.

Perhaps the most significant recent initiative to establish common ESG standards is the EU’s Taxonomy Regulation, which was adopted by the European Council on April 15, 2020 as part of a suite of sustainable finance reforms in the EU’s Action Plan on Financing Sustainable Growth.

The EU Taxonomy aims to provide a common classification system for environmentally sustainable economic activities. Users will be able to utilize the EU Taxonomy’s technical screening criteria to objectively illustrate the environmental credentials of portfolio assets.

From the lawyer’s perspective, while there may be some additional procedural hurdles in executing an ESG-linked/green finance transaction, it is unlikely to impact the overall timetable, and corporates, banks and funds are likely to ultimately benefit from the effort thorough increased investor interest, positive market perception and potential economic benefits.

We would further note that institutional know-how and finance technology have developed to the point that for the more commonly-utilized products, such as green bonds, the process is well-established and increasingly familiar to lawyers (and other advisors).

A promising outlook for convergence towards harmonized ESG standards across the globe

ESG-linked investment strategies and debt products are relatively new developments, so it is inevitable that it may take time for market participants to establish widely accepted standards.

However, two clear themes are emerging: first, the combination of investor demand, regulatory intervention and institutional desire to change means ESG principles are likely to become even more important to funds’ investment strategies. This, in turn, will drive funds’ demand for sustainability-linked financings, which further incentivize ESG-related activity.

Secondly, the increasingly ubiquitous demand for ESG criteria to apply to investments and financing products creates the need for a common language with which to describe such criteria and a consistent set of principles to use when assessing and reporting compliance.

Particularly in the current environment, people are focused on their impact on the planet and how to achieve a more sustainable way of life and more equal society. Achieving these objectives will require a profound reflection on how we use the planet’s resources and a meaningful change in people’s mindset. However, the role of legislators, legal and other advisors and supporters of ESG principles has, and will, provide some of the tools necessary to implement that change.