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ESG loans a new source of mining finance

Mining is not an industry that typically comes to mind in the context of a discussion on green finance, but it should. Two trends gaining momentum, the “greening” efforts of the industry and the expansion of green and environmental, social and governance (ESG)-linked loan products and sources, have resulted in green and ESG-linked financing becoming an increasingly relevant source of funding for the mining sector.
ESG loans a new source of mining finance ESG loans a new source of mining finance ESG loans a new source of mining finance ESG loans a new source of mining finance ESG loans a new source of mining finance

Cynthia Urda Kassis, Jason Pratt, Mehran Massih and Augusto Ruiloba*

Over the past several years, it has become widely acknowledged that large amounts of financing are needed to achieve environmental, social responsibility and governance goals established by the global community, specific countries or industry initiatives. This has translated into a growing array of innovative debt products no longer limited to so-called "green bonds" issued by renewable energy companies.

Green loans are loan facilities available to finance green projects, such as projects to increase energy efficiency, avoid carbon emissions, or reduce water consumption. A typical feature of green loans is the specified use of proceeds, sometimes including depositing proceeds in an account and conditioning withdrawals on certifications from external consultants verifying the project in accordance with an agreed standard.

ESG loans are loans or contingent facilities (such as a bonding/guarantee lines or letters of credit) that incentivize the borrower to meet predetermined sustainability targets (PSTs), such as increased energy efficiency or improved working or social conditions. The first step is for lenders and borrowers to agree on the PSTs - what metrics are relevant and how will they be measured. ESG loans are different from green loans in that the proceeds need not be allocated to an ESG project (proceeds could be for "general corporate purposes") but the terms of ESG loans (most notably the interest margin) generally become more (or less) favourable if the borrower meets (or fails to meet) its PSTs.

Common to both green and ESG loans are provisions that require borrowers to meet project-specific milestones, regular environmental/ESG reporting and third-party verifications or self-certifications of environmental requirements or PSTs.

Is there a regulatory framework?

The short answer is, not currently. Although this market remains largely unregulated, there are two high-profile voluntary guidance documents: the sustainability linked loan principles (SLLP) and the green loan principles (GLP), both developed by the Loan Syndication & Trading Association, Loan Market Association and the Asia Pacific Loan Market Association. The GLPs and SLLPs have much in common and both set out four core components, all of which must be satisfied for a loan to be green or ESG-linked.

As most jurisdictions, including the United States, have no green or ESG loan regulations, lenders and companies structure their facilities off the SLLPs and GLPs. The European Union, also an unregulated market, does have a proposed regulatory regime for sustainable finance. As part of that proposed regime, technical screening criteria for 67 activities that qualify as greenhouse gas mitigants were broadly agreed in content in December 2019. When finalised, this EU "taxonomy" is likely to emerge as a de facto standard on qualifying "green" activities, at least as long as the field remains comprised of more ad hoc standards.

One of the main risks of lacking a regulatory framework is the uncertainty as to what constitutes a green or ESG project. This can allow lenders or companies to promote a loan as green or ESG-linked when the project underlying it has dubious credentials. One of the results of "green washing" (as this practice is known) is that any reputational benefit that accrues to the participants in these types of loans will evaporate if they are perceived as not truly promoting green or ESG goals. Consequently, governments, industry groups and standardisation organisations continue to refine their vetting standards.

Green and ESG loans for mining companies?

Neither green nor ESG loans are limited to traditional green industries. Both products can be used in any industry to finance projects promoting green or ESG goals.

Mining is well positioned to tap this market. As described in works such as the World Bank's "The Growing Role of Minerals and Metals for a Low-Carbon Future", a low-carbon future means skyrocketing demand for strategic metals, such as lithium, graphite and nickel, all key to developing low-carbon technologies such as solar panels, wind turbines, and batteries for electric vehicles, and necessary for the integration of renewable energy into electrical grids. In addition, the mining sector has multiple opportunities for gains in energy and water use efficiency, reductions in air and water emissions and improvements in the context of community relations.

It is therefore not surprising that the participation of the mining sector in the green and ESG finance market is growing. On May 1, 2019, the World Bank, partnering with the German government, Rio Tinto, and Anglo American, launched the Climate Smart Mining Facility, the first fund dedicated to making mining for minerals climate-friendly and sustainable. In October 2019, Rusal announced the signing of a US$1 billion-plus ESG-linked pre-export finance facility with PSTs relating to improvements in environmental impact and sustainability practices. Previously, in April 2018, Polymetal International converted a US$80 million credit facility into an ESG-linked facility under which the PSTs were measured by a leading provider of ESG research and ratings.

We anticipate the green/ESG loan market will continue to hone eligibility criteria for mining, as well as other industries that have a prominent role to play in achieving a carbon-neutral future, such as demonstration of a transition to a lower carbon business model, implementation of key mitigation measures, and development of sustainability-focused governance frameworks.

Green and ESG loans can help mining companies meet their sustainability targets and comply with industry initiatives. Further, green and ESG instruments can provide mining companies with access to capital sources not otherwise available, for example, dedicated green and ESG capital pools, and lower funding costs, as well as a more certain path through investor credit approval processes, and improved reputations for green and socially-responsible business practices. In jurisdictions with applicable regulations, participation in the green or ESG loan market may also provide tax benefits.

*Cynthia Urda Kassis is a partner at global law firm, Shearman & Sterling, Mehran Massih and Jason Pratt are counsels at the firm, and Augusto Ruiloba is an associate