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Resurging opportunity for Sustainability-linked Loans in Indonesia

In February 2023, the Loan Market Association (LMA), the Asia Pacific Loan Market Association (APLMA) and the Loan Syndications and Trading Association (LSTA) re-issued the Sustainability-linked Loan (SLL) Principles and the SLL Guidance (both originally issued in 2019) to describe the five core components of an SLL to promote the development of SLL products.

On 4 May 2023, LMA also published model provisions with extensive drafting notes setting out points for parties to consider when undertaking an SLL transaction. SLLs are expected to continue to grow and be innovated in response to the rising demand and expectations from stakeholders for sustainable finance.

Indonesia, as a large and diverse emerging market with significant environmental and social challenges and opportunities, could potentially benefit from SLLs as a tool to support its transition to a low-carbon, inclusive economy. However, the SLL market in Indonesia is still nascent, with only a few deals completed so far. In the past year, we have seen SLLs used in financing various sectors, such as palm oil, cement and consumer goods. The main drivers of SLLs are the increasing awareness and demand from both borrowers and lenders to integrate sustainability into their business and financing decisions. In this publication, we will provide a general overview of SLLs and discuss the challenges, as well as the potential of developing SLL products in the Indonesian market.

Overview of SLLs

SLLs are different from green loans or social loans, which are loans that finance specific green or social projects or activities. SLLs are a type of loan instrument that incentivises borrowers to achieve predetermined Sustainability Performance Targets (SPTs) by linking the interest rate or other loan terms to the borrower’s performance on Environmental, Social and Governance (ESG) criteria. The SPTs can cover various ESG indicators, such as greenhouse gas emissions, renewable energy use, water consumption, waste management, social inclusion, gender diversity, human rights, etc. SLLs offer more flexibility compared to green loans as they can be used for general corporate purposes, as long as the borrower commits to improving its overall sustainability profile.

By their principles, SLLs are based on the borrower’s forward-looking and holistic sustainability performance, rather than the project-specific or sector-specific environmental or social impact of the loan. SLLs, therefore, encourage the borrower to and reward it when it does, improve its overall ESG performance across all of its business operations and the entire value chain, rather than focusing on a single, isolated aspect of its business. However, this also means that SLLs require the borrower to set and disclose clear and credible SPTs and Key Performance Indicators (KPIs) that reflect its sustainability ambitions and challenges and to report and verify its performance against those SPTs and KPIs regularly.

This may entail additional costs and effort for the borrower to establish and maintain a robust sustainability reporting and verification system, and to ensure the reliability and consistency of the data and information used for SLLs.

The Indonesian Financial Services Authority (OJK) has encouraged the implementation of sustainable finance practices for almost a decade through the issuance of Sustainable Finance Roadmap Phase I (2015-2019) and Phase II (2021-2025). Another milestone in the development of sustainable finance practice in Indonesia was marked by the issuance of the OJK Regulation No. 51/POJK.03/2017 (the OJK Rule 2017) which essentially requires all financial services institutions, issuers and public companies to formulate and implement sustainable finance action plans, including policies, strategies, programmes and targets for the integration of ESG aspects into their business and financing activities.

Incentives for Indonesian borrowers and lender

SLLs can strengthen the lender’s relationship and engagement with the borrower, as SLLs create a platform for regular dialogue and collaboration between the lender and the borrower on the SPTs and their achievements, as well as on the opportunities and challenges of sustainability in the borrower’s sector and market.

On the borrower’s side, SLLs can provide several benefits, which, among others, include enhancing the company’s reputation and credibility as a responsible and forward-looking company that contributes to global sustainability goals and responds to the expectations of its stakeholders, such as customers, employees, investors, regulators and communities. The other main benefit of applying SLLs is that it reduces the borrower’s financing costs and improves its access to capital, as SLLs can offer lower interest rates or more favourable loan terms for borrowers that achieve or improve their SPTs.

On the other hand, to align with the mandate under the OJK Rule 2017, Indonesian banks must incorporate increased use of SLLs in their lending portfolio into their sustainability strategy and commitments. An offering of SLL terms can be an avenue to demonstrate the lender’s leadership and innovation in the loan market, as SLLs represent a novel and differentiated product. Negotiation of SLL terms generally showcases the lender’s expertise and value proposition in sustainability finance.

The OJK Rule 2017 provides for certain incentives from OJK to encourage growth in performance and compliance with sustainable finance practices. Currently, these only consist of inclusion in the improvement in competency of human resources and awarding of a sustainable finance award. It remains to be seen if OJK will extend it to more definitive financial incentives, like the one applied to green bond instruments by giving a certain discount on the registration fee.

SLLs in the Indonesian loan market

SLLs have significant potential to grow and develop in the Indonesian loan market amidst the challenges embodied in their novelty. They can offer various benefits and opportunities for both borrowers and lenders, as well as for the Indonesian economy, society and environment. SLL financing products can be an appealing tool for, among other things, re-profiling existing exposures, as they inherently support improvement in ESG performance for both financial institution lenders and Indonesian company borrowers. In addition to that, they would benefit from a new platform of relationship channels created by exploring SLL structure in the emerging Indonesian market.

Developing SLLs in the loan market will not be without challenges that may hinder or limit their adoption and expansion in Indonesia. From our observation and experiences in advising SLL-based loan syndication deals in Indonesia, one of the imminent challenges is the lack of awareness and understanding of SLLs as a distinctive financing product. Some may mistakenly consider SLLs to be similar to, or inseparable from, green loan products that require the Indonesian borrower to have an underlying green project in compliance with green loan principles. Compared to green loans, SLLs offer moreflexibility in terms of the use of loan proceeds, because they are not bound to a particular project. The precedent suggests that Indonesian borrowers, as well as financial institutions, can improve their ESG performance by re-profiling their existing loan exposure into an SLL product.

SLLs are relatively new and innovative in the Indonesian loan market and, at present, there is no specific law or regulation in Indonesia that governs or regulates specific requirements on the use of SLLs in loan documents. As with other commercial terms, incorporation of SLLs in the loan documents is subject to the general laws and regulations that apply to lending activities that allow the adoption of international best practices, including those set out in the guidelines issued by the APLM, LMA and LSTA.