Sleeping Beauty or Sleeping with the Enemy? A Closer Look at Sleeping SLLs
Andrew Prasad, Director and Senior Legal Counsel, SMBC Bank International
Natalya Tueva, Executive Director, Head of Sustainable Finance, Loan Capital Markets EMEA, SMBC Bank International
Tim Rennie, Partner, Ashurst LLP
“Sleeping”1 is a term often seen put before “sustainability-linked loan” (SLL) and can be used to express an intention for a brief nap, a prolonged hibernation, or an eternal slumber.
But what does it actually mean? Should the construct be regarded with mistrust or is it simply misunderstood?
With 35% of 2023 European sustainability-linked leveraged loan transactions incorporating sleeping SLL terms, we seek to explore whether the exceptional has become somewhat normalised.
1. Also known as “agree to amend”, “shell SLLs” and “inactive SLLs” amongst other things.
1. What is a sleeping SLL?
A sleeping SLL is essentially a conventional loan agreement that contains provisions to convert the facility to a SLL2 after the closing date, i.e. the mechanics of a SLL are baked into the documentation, with these mechanics to be activated when the SLL components are agreed post-origination.
The sustainability aspects of the loan – the key performance indicators (KPIs) and/or sustainability performance targets (SPTs) – are therefore delayed.
2. As discussed in the Best Practice Guide to Sustainability-Linked Leveraged Loans published jointly by the LMA and The European Leveraged Finance Association
2. An exception to the rule
The Guidance to the Sustainability-Linked Loan Principles (SLLP) states that in “exceptional instances” a sleeping SLL may be used3. Examples of exceptional instances include:
Merger & Acquisition (M&A). For a company that is undergoing an M&A activity, it may be challenging to scope the KPI(s) and/or calibrate the SPTs at the time of the loan origination due to time constraints. Additionally, the effect of the transaction would need to be clearly understood on the group’s overall ESG strategy.
Company’s governance, such as a delay by the company in obtaining its internal governance sign off, for example by the executive committee on the proposed KPI(s) and/or SPTs.
Concurrent SLLs where the SLL components of a company’s core facility dictate the SLL construct of its other global facilities.
Fund Finance. Practical challenges have been observed4 in applying the SLLP in the context of fund finance transactions for various reasons, including difficulty of setting KPIs due to a fund’s limited physical operations, uncertainty of investment pipeline or a lack of consistent metrics across a fund’s underlying investments; limited historical ESG data on borrowers, the fund or sponsor, and the underlying investments.
But should these exceptions remain exceptional or be developed to enhance the toolkit offered to borrowers to aid them on their sustainability journey?
3. Para 3.B.II.e) in the Guidance on Sustainability-Linked Loan Principles produced jointly by the APLMA, LMA and LSTA. 4. See A_Guide_to_the_Application_of_the_SLLP_in_Fund_Finance.pdf (lma.eu.com) for more detail.
3. Guidelines and guardrails
Sleeping SLLs have been adopted as the parties anticipate the terms incorporated pre-signing will have a positive impact on keeping costs down and the speed of adoption for the parties once the outstanding SLL terms are commercially agreed.
However, parties should be mindful of previous criticisms for the sleeping SLL construct, which resulted in adverse headlines and acted as a contributing factor to the 2023 FCA review of the SLL market5. It is therefore imperative that when adopting a sleeping SLL construct, the following guidelines be strictly adhered to:
No publicity
Until the KPI(s) and/or SPTs are agreed and set, and all other core components of the SLLP are met, the loan is not a SLL and no party should communicate, or refer to it, as such.
Ratification timeline
Implementation and ratification of all required SLL components by the lenders should take place no later than twelve months post origination.
Consent
Parties must ensure that the KPI(s) and SPTs undergo the same scrutiny and attention as they would have had they been proposed at the outset of the transaction and the Guidance on SLLP recommends that all lender affirmative consent be required to the setting of any KPI(s) and/or SPTs, to maintain the integrity of the product. Where this is not practical due to the size of the syndicate, parties may agree to a lower threshold for consent, e.g., Majority Lender consent.
Furthermore, consideration should be given to:
Pricing
Any sustainability-linked margin adjustment should be agreed by the borrower at the outset.
Supplementary ESG material and transparency.
The SLL ratification process should be accompanied by detailed ESG lenders presentation sufficient to allow lenders to satisfy themselves as to the borrower’s proposed KPI(s), SPTs and other credentials to confirm that the documentation meets the SLLP.
Internal reporting.
Lenders are not expected to include a facility in their internal reporting of SLL transactions until the sleeping SLL terms are switched on, and those terms meet that lender's internal SLL requirements.
“Incorporating a streamlined ability to include a sustainability-linked feature in a loan at a later date is one that must be carefully considered, but may be a helpful tool for borrowers. Ultimately, it is essential that the rigor of constructing the sustainability-linked feature when it comes mirrors that of a Day 1 SLL.”
Tess Virmani – Deputy General Counsel and Head of Policy at the LSTA
4. Into the detail
The extent to which SLL provisions can be agreed pre-signing will depend upon the specifics of each transaction and should in any event reflect the SLLP. Before putting pen to paper – or having your legal adviser do the same – specific consideration should be given to:
- Whether only the KPI(s) and/or SPTs need to be agreed post-signing or whether other SLL provisions also need agreeing;
- How the SLL amendments will be incorporated into the facility agreement (e.g. by way of a certificate, amendment letter or amendment and restatement agreement requiring conditions precedent such as legal opinions);
- What level of consent is required to approve any SLL amendments, i.e. can a lender be dragged into a SLL financing which has SLL terms that do not satisfy its internal criteria; and
- Any additional requirements sustainability coordinator(s) and lenders may need to satisfy regarding sleeping SLLs.
The answer to these questions will have implications regarding the customer relationship, the economics under the financing and consequences regarding other internal and external items.
In consideration of the above, sleeping SLL terms should use the LMA's Draft Provisions for SLLs6 as far as possible to ensure alignment with the SLLP, noting that the sleeping construct itself is not catered for. As the KPI(s) and/or SPTs are often not agreed on sleeping SLL transactions at signing, additional terms will be necessary to incorporate the parties' agreement of these components and, only then, for the parties to label the facility as a SLL. The LMA recommends that the sustainability co-ordinator assists with the agreement of the KPI(s), SPTs and any other amendments required to "switch on" the SLL terms. However, some banks may be apprehensive regarding agreeing to terms or a transaction process where no detailed settled market practice exists for fear they and their financing are viewed as “leading the market”.
“The sleeping construct is something we are deliberating from a drafting perspective as we approach the first anniversary of the Draft Provisions. The LSTA have successfully incorporated guardrails for sleeping SLLs into their own Drafting Guidance for SLLs, and this is something we will consider adding to our own Draft Provisions later this year.”
Gemma Lawrence-Pardew – Head of Sustainability at the LMA
5. Looking ahead
If not applied correctly, use of a sleeping SLL construct could raise SLL integrity-related concerns, increasing greenwashing risk and reputational harm for those parties involved. However, whilst it pays to be mindful of the potential risks and criticisms occurring from a sleeping SLL construct in each individual instance, the potential positives should not be underplayed.
As companies continue to navigate the regulatory landscape, which has become a critical consideration when implementing their sustainability strategies, a sleeping SLL could be a helpful bridge available to a borrower in order to find the right balance between a commitment to further its sustainable finance strategy and its evolving sustainability reporting obligations.