Sustainability-Linked Instruments ' Helping In The Transition To Sustainable Economy?

• Published date: 30 June 2023
• Subject Matter: Finance and Banking, Environment, Debt Capital Markets, Environmental Law
• Law Firm: Borenius Attorneys Ltd
• Author: Saara Haapam'ki

Many of us have heard companies and banks talking about sustainability-linked instruments. But what actually are these instruments and what is their contribution to sustainable development? Are there any risks involved and what are the main benefits of such instruments?

Sustainability-linked instruments tied in with performance

A sustainability-linked instrument, i.e. a loan or a bond, is an instrument where the pricing of the instrument is tied to the sustainability performance of the borrower. The borrower agrees together with the lenders or bond arrangers on certain key performance indicators (KPIs) that are monitored throughout the life of the loan or bond.

If the borrower fails to reach the targets set for the KPIs, the pricing of the instrument goes up, meaning that it will become more expensive for it. Furthermore, the loan's margin decreases if the targets will be reached. Most of the KPIs are currently related to the environmental aspects, most often to climate, with greenhouse gas emissions being the most popular KPI in the sustainability-linked instruments.

The sustainability-linked instruments market has overgone a huge growth in the last couple of years and, nowadays, almost all financing received by large companies include a sustainability link. The main reason for the sustainability-linked instruments becoming popular instruments is that they are flexible and easy-to-approach instruments that the companies can also use to partly accomplish their sustainability strategy and to improve their sustainability-related communication.

There are many advantages on using sustainability-linked instruments, such as, they are not heavily regulated, and the borrower is not required to have a specific green project. However, not all the companies are able to use these instruments. To be able to determine ambitious and demanding targets, the company needs to have its sustainability strategy already in place.

The legal framework for these instruments

Even though the sustainability-linked instruments market has been growing during the last year, there are still not so many regulations in place for the sustainable finance and, therefore, these instruments are not standardised, which can lead to problems with greenwashing. For example, one cannot know if the company is really setting competitive targets or targets that it would reach in any case. The Sustainability-Linked Loan Principles and Sustainability-Linked Bond Principles established by different...