Trade finance:

How to set up a sustainability-linked loan

Authors:
Gemma
Lawrence-Pardew,
Director - Legal,
LMA

Adam Hearne,
CEO and Co-founder,
CarbonChain

Over half of the world’s greenhouse gas (GHG) emissions come from the global commodities market¹. Commodity traders and their lenders are therefore central to the climate challenge. Their supply chains and portfolios face major disruption in the net-zero transition, from regulatory risks to stranded assets.

Being central to the climate challenge, traders and banks have the power to
influence and decarbonise supply chains.

With this power comes opportunity. Driven by leadership recognition, legislation and portfolio climate targets, many trade finance providers want to support transparent and lower-carbon commodity trading. They’re willing to incentivise traders financially to do more towards net zero, encouraging the pursuit of ambitious transition strategies.

Yet there’s a barrier: a huge data gap. It’s complex to track the production, processing and flow of agricultural and extractive commodities, let alone the emissions created. How can banks and traders identify the low-carbon trades, when supply chain emissions are so difficult to measure?

In this guide, we will look at how sustainability-linked loans² can be used to drive a decarbonisation strategy, as well as capture data in this area, setting out five key steps for commodity traders and banks to consider.

What do we mean by sustainability-linked loans?

The SLLP define sustainability-
linked loans as “Any types
of loan instruments and/
or contingent facilities (such
as bonding lines, guarantee
lines or letters of credit) which
incentivise the borrower’s
achievement of ambitious,
predetermined sustainability
performance objectives”.

These sustainability performance
objectives capture a wide
range of categories across
environmental, social and
governance activities. However,
for the purposes of this guide, we
shall be focusing exclusively on
the reduction of GHG emissions.

Key Steps

1. Measure

As the saying goes, ‘If you don’t measure it, you can’t manage it’. So, Step 1 is to fill the data gap with a GHG emissions inventory, and understand the existing carbon impact of the trader’s portfolio.

This carbon accounting should be comprehensive, covering:

•ades across at least a 12-month period, even if the exercise begins all tr
with a sample;

• the end-to-end supply chain for each trade (including production,
ocessing and transport-related emissions, from mine to port and beyond); pr

•-level breakdowns across the supply chain, to build up accurate trade-asset
vel calculations as well as to pinpoint the biggest emissions sources; le

• all GHG emissions (calculated as carbon dioxide equivalent: CO₂e); and

• a summary of emissions intensity as well as absolute emissions.

Accuracy is important. Broad-based estimates won’t do, as you need to be able
to compare performance between similar trades and traders (which can vary
hugely) and identify granular changes in performance over time.

Imprecise estimates also cloud
carbon hotspots, hiding the biggest
carbon risks. Primary data should
be used wherever possible, or
precise estimates from verified
sources, along with a transparent
methodology aligned with the GHG
Protocol³.

Apart from being the first step
to unlocking sustainable finance
opportunities, measuring emissions
has extra benefits for commodity raders. It reveals how supply chains
will be impacted by new regulations
like the EU CBAM⁴, and helps
traders meet reporting requests and
requirements.

2. Benchmark

Next, it’s time to contextualise the data.

Traders need to map emissions intensities, as well as absolute emissions,
against relevant benchmarks. These could include:

• industry standards and guidelines;

• external ratings or metrics;

• industry averages, to assess performance relative to peers; and/or

• pre-existing green finance standards set by the bank.

Emissions intensity by brand

Ships emission factors against the Poseidon Principles targets

To ensure the insights are actionable
and valuable, benchmarking should
be done:

• per asset, trade, vessel and
ommodity, to pinpoint carbon c tspots and existing low-ho
carbon solutions; and c

• across all commodities, to
Kildisart
assess performance of the
whole portfolio against
De Rasher Counters, global standards or peer
xisting emissions-reduction e
targets.

3. Set the targets

The next step is for the trader to look ahead. The trader needs to present, and
the bank needs to agree on, an overarching climate vision and goal, together
aligning on what the trader should achieve to unlock the economic benefits of
entering a sustainability-linked loan.

This should be translated into sustainability performance targets (SPTs), as
measured by corresponding key performance indicators (KPIs). The scope of
trades covered, and time frames, should be defined. Traders can use GHG
inventory and benchmarking data, as well as any existing goals, such as
science-based targets⁵.

The SLLP require that KPIs be material to the borrower’s core sustainability
and business strategy, and address relevant environmental, social and/or
governance challenges of the industry sector, indicating real, meaningful steps
towards decarbonisation. SPTs should be set in good faith and remain relevant
(so long as they apply) throughout the life of the loan, encouraging ambitious,
positive change.

When setting SPTs relating to KPIs
for emissions reductions, traders
should consider:

• whether to use emissions
density, absolute emissions or int
th as an indicator; bo

• including a KPI for each
commodity to reflect each c
tinct industry standard and dis
eduction potential; r

• including specific and ambitious
Ts focused on the most SP
polluting commodities, to ensure
highest impact;

• covering their whole portfolio,
rather than just the bank’s r
ed trades (to ensure SPTs financ
or financed trades cannot be f
y switching finance met b
bces for high-emitting sour
ades); and tr

• feasibility, such as product
changes required, business
model transformation, and time
frames.

KPIs for emissions reductions
(absolute and intensity-based)
should be achieved without the use
of offsets, in order to align with the
GHG mitigation hierarchy⁶. However,
traders may decide to compensate
for remaining emissions through the
purchase of credible carbon offsets⁷,
as an additional term of the loan,
or with the money the trader saves
when accessing discounts.

The roll-out of sustainable trade
finance is still nascent, with no
well-established market standards.
This presents a significant
opportunity for leadership in
setting ambitious emissions-
reduction goals.

4. Seal the deal

The KPIs and SPTs should be clearly documented in the loan agreement,
ensuring the economic characteristics of the sustainability-linked loan are
clearly defined. Parties might agree to govern how savings should be spent
(for example, invested back into value chain climate action), but this is for
commercial consideration to be decided on a case-by-case basis.

Parties should ensure the loan agreement covers:

• the verified baseline or science-based reference point selected for
movement of KPIs; impr

• how the performance against SPTs will be tracked (for example, in-house or
through a consultant or carbon accounting software provider?); and thr

• how traders are to evidence that calculations are accurate, i.e. who will
verify the data? Is the third-party provider’s methodology validated as v
aligned with the GHG Protocol?

Of fundamental importance is ensuring all five components of the SLLP are
covered, being:

1. Selection of KPIs 4. Reporting

**2.**alibration of SPTs C **5.**erification V

3. Loan characteristics

5. Track and review

Tracking should be done on an ongoing basis, so that the trader can assess the impact of supplier changes and make
further interventions. When calculating emissions at the end of the time frame, traders should use the same methodology
and approach as used to determine the baseline, to ensure it’s comparable. If using a different methodology (for example,
due to improved methodological standards or better access to data) this should be reported with an explanation.

Traders can use their emissions reductions to meet customer demand and access further opportunities in their net-
zero journey.

Footnotes and sources

¹ossil fuels account for 73% of the world’s greenhouse gas emissions ( F Climate Watch dashboard data). According to the United Nations Environment
Programme’s Global Environment Outlook, 2019, the extraction and processing of materials, fuels and food are responsible for 50% of global carbon
xide emissions. dio
²s supported by the LMA, APLMA and LSTA's Sustainability-Linked Loan Principles (SLLP) and supporting Guidance, A
https://www.lma.eu.com/application/files/9216/4873/5603/Sustainability-Linked_Loan_Principles_31_March_2022.pdf and
https://www.lma.eu.com/application/files/9416/4873/5604/Sustainability-Linked_Loan_Principles_Guidance_31_March_2022.pdf
³https://ghgprotocol.org/
⁴ https://www.carbonchain.com/blog/what-you-need-to-know-about-the-eu-cbam
⁵https://sciencebasedtargets.org/sectors
⁶https://www3.weforum.org/docs/WEF_NCSA_NCS_for_Corporates_2021.pdf

⁷https://www.carbonchain.com/blog/good-offsets-bad-offsets-a-guide-for-the-commodities-sector