Overview of sustainability-linked loans

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-An emerging and promising financing substitute

Surabhi Chura | corplaw@vinodkothari.com

There has been a growing emphasis on sustainability across various sectors including finance, especially, with a growing mandatory requirement of disclosure of sustainability practices by companies around the world. Various sustainability-linked finance products are designed to promote the ESG objectives of the borrower while providing financial solutions.

Traditionally, loans have remained the most common way of raising finance, and sustainable finance is no exception to the same. These loans may be labelled as green loans, social loans, sustainable loans etc. Various organisations have issued voluntary guiding principles around the same[1]. A commonality in these loans is the restriction on the “use of proceeds” – that are directed towards the green, social or sustainable objectives of the borrower. Another form of sustainable finance through loans is Sustainability-linked Loans (SLLs), where the loan contains certain sustainability-linked terms. Contrary to typical green finance products, which allocate funds for designated green projects or assets, SLLs align the loan conditions with the sustainability performance of the borrower.

Other instruments of raising sustainable finance can be through the issuance of labelled bonds or GSS+ bonds. Read more about the same in our article – Sustainable finance and GSS+ bonds. One of the more recent innovative ways of financing sustainability objects of the borrower can be through Sustainability-linked derivatives.

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Sustainability linked derivatives: An instrument with a potential

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– Vinod Kothari, vinod@vinodkothari.com

Sustainability-linked loans and bonds have been surging globally. While there has been a dip in the recent periods (Q3 and Q4 of 2023) owing to tightening of regulatory conditions, the global volumes of sustainability-linked loans stood at around $ 400 billion[1].

However, there is another instrument – a derivative, which also has a linkage with sustainability targets, and that is making a global buzz. ISDA, having named this Sustainability Linked Derivatives or SLDs, is creating proper documentation basis to take this market forward. As of now, the market for SLDs is neither large nor highly standardised, but as credit defaults rose from nowhere and from a purely OTC product into being in the very thick of the global financial crisis, SLDs also merit close attention.

What is an SLD?

Think of usual derivatives in financial business – it will be an interest rate swap, or cross currency swap/FX forward. An SLD adds a sustainability-linked overlay on a typical IRS or FX hedge transaction.

For instance, assume Borrower X has taken a floating rate loan of $ 100 million, say at SOFR + 100 bps. X now hedges interest rate risk by entering into an IRS with Bank A, whereby Bank swaps this for a fixed rate of 4.5%.

Here, if we add an SLD overlay, Bank A will agree to provide a discount of, say 5 bps if X is able to meet certain specified sustainability KPIs. On the contrary, if X fails to meet the KPIs, then X pays a penalty of equal or a different amount. Depending on the agreement, the discount or penalty, or bonus/malus, may either be exchanged between the counterparties or by spent by either counterparty by way of a donation  for a sustainability cause.

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Directors’ Responsibility towards Climate Change: Lessons from Recent Litigation

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SEBI approves changes in SSE framework – Eases registration & listing of NPOs

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– Payal Agarwal, Senior Manager | corplaw@vinodkothari.com

(Updated as on November 28, 2023)

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Carbon credit markets: building the ecosystem for trading in India

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– Payal Agarwal, Manager (payal@vinodkothari.com)

The consequences of climate change and the need for a positive climate action need no introduction in the present world. What once remained a matter of concern for the so-called “environmental activists”, gradually traveled their way to the government as countries committed towards achieving “net zero”. Climate action requires involvement of the masses, and therefore, the government is coming up with new regulatory devices towards developing climate action on a large scale.

India is no exception to the same, and following the footsteps of other countries, has proposed to develop a compliance mechanism and domestic market for carbon credits in India. Regulatory inclusion is provided to carbon credits in India by way of an amendment to the Energy Conservation Act, 2001 (“ECA”). Carbon credits are a form of emission trading schemes (ETS), that incentivize the reduction in emissions, against the offsetting of higher emissions by other market participants. A brief comparison of the domestic ETS in other parts of the world, and the existing emissions trading markets in India can be referred to at Emission law amendments: Laying the framework for Carbon trading market in India.

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Financing transition from “brown” to “green”

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SEBI prescribes additional requirements for transition bonds

– Mahak Agarwal, Executive | corplaw@vinodkothari.com

Need for transition finance

As climate change and its impacts continue to remain one of the major concerns of any economy, transition finance is a step towards effectively transforming carbon emissions and combating climate change.

‘Transition Bonds’, as the word speaks for itself, are debt instruments that facilitate transition of a carbon-intensive business into decarbonizing business and eventually achieving the Net Zero emissions targets.

While it is true that change is the only constant, it cannot be denied that the same can often be challenging. Similar is the case with enterprises looking to metamorphosize their activities into a sustainable form. A huge amount of finance is required for carbon-intensive sectors to decarbonize and it is here that transition bonds find their application.

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Regulating ESG Rating Providers in India

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– SEBI approves regulations for ERPs through amendments to CRA Regulations

– Payal Agarwal, Deputy Manager (payal@vinodkothari.com)

As ESG and climate change concerns assume global priority, there is a growing interest among businesses to claim their offerings, products or structures to be green.  This  growing interest of a variety of stakeholders has led to the emergence of ESG Rating Providers (“ERPs”) for ranking an entity’s ESG profile, providing “green” or other coloured labels, or giving other affirmations as sustainability or sustainable-linkage. Unlike credit ratings, ESG ratings are currently not within the direct domain of securities regulators; however, to the extent ESG ratings relate to securities offerings or financial products, the securities regulators claim to have jurisdiction., he International Organization of Securities Commissions (“IOSCO”) has been working towards evolving recommendatory standards. IOSCO published its final report on Environmental, Social and Governance (ESG) Ratings and Data Products Providers (“IOSCO Consultation Report”) in November, 2021.

Following the same, SEBI released a consultation paper on Environmental, Social and Governance (ESG) Rating Providers for Securities Markets (“ERPs Consultation Paper”) on 24th January, 2022, and on the basis of the public consultation as well as global regulatory developments, had proposed a draft regulatory framework for ERPs (“Draft ERP Framework”) on 22nd February, 2023. Recently, on 29th March, 2023, SEBI has approved to bring a regulatory framework for ERPs in India, by inserting a new chapter to the existing SEBI (Credit Rating Agencies) Regulations, 1999 (“CRA Regulations”).

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SEBI revises framework for green debt securities

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– Alignment with international standards and avoidance of greenwashing

– Payal Agarwal and Shreya Salampuria | corplaw@vinodkothari.com

Sustainability labeled bonds, more popularly known as GSS+ bonds, are looked upon as one of the primary means of raising funds towards sustainable development. The same has been discussed in Sustainable finance and GSS+ bonds: State of the Market and Developments. India is also not oblivious to the concept of GSS+ bonds, and companies in India have also been issuing such bonds, in one or more forms.

The issuance of green debt securities (“GDS”) in India was initially formalized through a circular issued  by SEBI in 2017 in this regard, later absorbed under the SEBI (Issue and Listing of Non-Convertible Securities) Regulations, 2021 (“ILNCS Regulations”) read with Chapter IX of the Operational Circular on the same. The regulatory framework for GDS in India has since been reviewed, and following a Consultation Paper on Green and Blue Bonds as a mode of Sustainable Finance (“Consultation Paper”) dated 4th August, 2022, SEBI, in its meeting dated 20th December, 2022 (“Board Meeting”) has approved amendments to the existing regulatory framework for GDS issuance. The press release of the Board Meeting reads as “in the backdrop of increasing interest in sustainable finance in India as well as around the globe, and with a view to align the extant framework for green debt securities with the updated  Green  Bond  Principles (GBP) recognised by IOSCO, SEBI undertook a review of the regulatory framework for green debt securities.”

Pursuant to the review of the regulatory framework for GDS, the following has been notified –

In this write-up, we intend to discuss the revised regulatory framework for GDS issuance in India.

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India’s “green growth”: is the green skin-deep?

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– Payal Agarwal, Deputy Manager | corplaw@vinodkothari.com

Talking about green growth may seem like rhetoric. From policy-makers to economists, from corporate governance experts to environmentalists, everyone seems to be having “green growth” on the top of the agenda.

The Economic Survey dedicated a full chapter to climate change and related issues. The Budget also has green growth as one of the seven saptarishis, to guide the FM’s plans for our financial future.

Need of the hour

India has been taking small steps towards reaching its commitment to the net-zero emissions goal by 2070, as compared to a majority of countries committing to reach the net-zero targets by 2050. While the country contributes to a very low percentage of global emissions (only 4% of the cumulative global emissions from the period 1850-2019[1]), the global nature of the problem of climate change is what makes the country equally vulnerable to the problem, if not more. Further, given its long coastline, monsoon-dependent agriculture, and large agrarian economy, India is considered to be one of the most vulnerable countries to the climate change issue[2].

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As social stock exchanges seem imminent, auditors get ready with social audit standards

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ICAI and ICSI issue social audit standards

– Sharon Pinto & Kaushal Shah (corplaw@vinodkothari.com)

Background

As we understand, the concept of Social Stock Exchanges (‘SSEs’) have been brought under the regulatory purview of Securities and Exchange Board of India (‘SEBI’) for listing and raising of capital by Social Enterprises, the details of which can be read in our article Social stock exchanges: philanthropy on the bourses as well as our other resources linked with the concept of SSEs and social sectors.

Social Enterprises are defined under regulation 292A (h) of the SEBI (ICDR) Regulations, 2018 (‘ICDR Regulations’) and are expected to be engaged in the specified activities provided therein. With the objective to assess the impact created by such social activities by the Social Enterprises, Self Regulatory Organisations (‘SRO’s) recognised under ICAI, ICSI and such other bodies as may be prescribed by SEBI have been considered to be eligible to act as platforms to register Social Auditors. ICAI has approved the formation of an SRO named ‘Institute of Social Auditors of India’ while ‘ICSI Institute of Social Auditors’ is the recognsied SRO under ICSI. Such auditors are also required to undergo a certification program conducted by National Institute of Securities Market (‘NISM’).

ICAI has recently sought interest for the initial empanelment of Social Auditors.[1] The eligibility criteria for empanelment as a Social Audit firm requires having a track record of minimum three years of conducting social impact assessment. Further, average annual grants or expenditure of social enterprise of the last 3 financial years should be atleast Rs. 50 lakhs and the firm should have suitable human resources in the field of social development having experience of usage of relevant methodology of social audit. The disqualifications includes any individual or any of the partner/director of an entity being convicted for an offence of moral turpitude or declared as an undischarged insolvent/bankrupt or has been debarred by SEBI.  

To put it in simple terms, Social Auditors are required to conduct Social Audit of the activities carried on by Social Enterprises. To aid the Social Auditors in carrying out the Social Audit, both the SROs being ICAI and ICSI have rolled out the Social Audit Standards (‘SAS’) to assist and guide their empanelled auditors for the purpose of carrying out the audit in accordance with the SAS Framework. Looking at the imminence of SSEs to come into reality with SEBI granting in-principle approval to both BSE and NSE in December, 2022, SROs have rolled out SAS for the quick reference and guidance for their registered auditors.

In this write-up, we have covered the key takeaways from the SAS and its relevance, applicability as well as mapping with the global principles on social audit.

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