Guidance framework on Sustainable and Sustainability linked lending by financial institutions

1 CIRCULAR F. No 584/ IFSCA/Sustainable Finance- LF/2022-23/001 April 26, 2022 To, All IFSC Banking Units (IBUs) and Finance Company/Finance Units (FC/FUs) in the International Financial Services Centre (IFSC) Guidance framework on Sustainable and Sustainability linked lending by financial institutions The International Financial Services Centres Authority (IFSCA) directs the IBUs and FC/FUs operating in the IFSC, undertaking lending activities from IFSCs, to develop a comprehensive Board approved policy1 on green/social/sustainable/sustainability-linked lending by March 31, 2023, based on the framework discussed below. From the financial year, beginning April 01, 2023, the IBUs and FC/FUs undertaking lending as one of the permitted activities shall have at least five per cent of their gross loans and advances directed towards green/social/sustainable/sustainability-linked sectors/facilities. The five percent target shall be computed on incremental loans and advances in a financial year i.e. in comparison to the amount as at the end of the previous financial year. The Authority may, as suitable, review and amend the same, from time to time. In case, if the IBU or FC/FU is unable to meet the above targets it shall report to the Authority explaining reasons for non-compliance of the same and shall provide future action plan towards ensuring compliance with this framework. 2. An entity licensed/registered post issuance of this framework shall get a time period of 12 months, from the date of commencing its operations, to put in place a Board approved policy, as mentioned above. The lending target shall be applicable from the beginning of the new financial year, post adoption of the Board approved policy. 3. The framework is divided into four broad areas: Part A: Guidance on green/social/sustainable lending2. Part B: Guidance on sustainability linked lending. Part C: Guidance on short term financing/working capital finance (green / social / sustainable). Part D: Reporting framework. (The reporting will begin from half year ending September 30, 2023) 1 In case of IBU, policy needs to be developed by ‘Governing Body’. The Governing body shall have the same meaning as defined in the module 2 on ‘Governance’ in the IFSCA Banking Handbook on General Directions as amended from time to time. 2 The terms green/social/sustainable are used interchangeably in the framework. IBUs and FC/FUs are required to develop the internal policy based on the differentiation as existing in the standards and frameworks referred to in this circular. 2 Part A: Guidance on Green/Social/Sustainable lending 4. The internal Board approved policy of the lending institution shall duly factor in the principles laid down in at least one of the international standards / principles listed below. The internationally accepted standards are recommended as they are aimed at providing a consistent methodology for use across the loan market, whilst allowing the loan product to retain its flexibility and preserving the integrity of the green/social/sustainable market while it develops. These standards broadly aim at recommending the structuring features, disclosure and reporting associated with lending or issuance of financial product. The frameworks that can act as a guiding tool are: a. Green Loans Principles developed by Loan Market Association (LMA) b. Social Loan Principals developed by Loan Market Association (LMA) c. Bond Principles developed by International Capital Markets Association (ICMA) d. Climate Bond Standards by Climate Bonds Initiative e. Any other globally recognized standards or any framework or methodology specified by a competent Authority in India. 5. The core components of such policy on lending shall cover aspects such as: a. Borrower assessment process, b. Assessing the use of proceeds and appropriately describing it in the legal documentation of the loan facility, c. Process to be adopted for project evaluation and selection, management of proceeds, d. Reporting mechanism, e. Monitoring either internally or through external reviewer, and; f. De-classification of lending facilities. 6. The IBUs and FC/FUs may establish an in-house process to assess the borrower and the eligibility of loan facility (project/trade/ working capital finance facilities, etc.) in meeting the identified Environmental/Social/Sustainable objectives. Individual facilities may be assessed on a case-to-case basis for whether the level of ‘green’ is sufficient, whether the borrower and the lenders have mutually agreed to classify such facilities as ‘green’, ‘social’ or ‘sustainable’ and to put measures in place to avoid greenwashing and similar instances. 7. Declassification mechanism shall be pre-agreed upon between the lender and the borrower so as to maintain integrity and compliance of the facility as per the initial classification as green/social/sustainable. Declassification of a facility shall result in an immediate discontinuation on the publicity of the facility as green/social/sustainable in any manner. The Board approved policy shall have a strategy towards meeting the asset- liability 3 mismatch which may arise due to such declassification. However, at any point in time such lending shall be in compliance with the standards adopted by the IBU or FC/FU. Part B: Guidance on Sustainability linked lending 8. Sustainability linked lending incentivizes the borrowers’ sustainability performance by linking the interest margin to the improvement of the companies’ ESG score or to the improvement on tailored/predefined sustainability Key Performance Indicators (KPI) as measured by predefined Sustainability Performance Targets (SPTs). The sustainability linked policy so developed shall be adopted on a case specific transaction based on underlying characteristics of the transaction. The loan facility may be labelled as sustainability linked provided that it factors in the principles laid down in the international standards listed below: a. Sustainability Linked Bond principles developed by ICMA, or, b. Sustainability Linked Loan Principles jointly developed by Asia Pacific Loan Market Association, LMA and Loan Syndications and Trading Association, or, c. Any other globally recognized standards or any framework or methodology specified by a competent Authority in India. 9. Broadly, the lending policy on sustainability linked lending may cover aspects such as: a. Borrower assessment, b. Manner of selection of Key Performance Indicators (KPI), c. Calibration of Sustainability Performance Targets (SPT), to be set in mutual agreement between borrower and lender, d. Financial and/or structural characteristics to incentivize the achievement of the SPTs and /or involve a penalty if the SPTs are not met, e. Suitable provisions for reporting and f. Mechanism for verification of performance. It may be noted that the penal mechanisms may be as mutually agreed between the borrower and the lender while finalizing the terms of loan agreement. Part C: Guidance on short term financing/working capital finance (green / social / sustainable). 10. There has been an increase in the instances of classifying or labelling trade finance transactions as sustainable. Recently, there has been a positioning paper on the subject rolled out by International Chamber of Commerce3. Considering the shift towards the labeling 3 https://iccwbo.org/publication/icc-standards-for-sustainable-trade-and-sustainable-trade-finance/ 4 and classification of short term finances into green/social/sustainable it may be prudent that the Board approved framework on sustainable lending also enables such classification wherever possible. While drafting internal policies, reference can also be drawn for evidencing the greenness of the associated projects or activities by associating to the Industry Green Standards wherever applicable. The borrower may report to the lender such information (including relevant certifications) which ascertains that the proceeds of the facility availed by the borrower (as part of sustainable trade finance, working capital finance etc.) are used for financing green/social/sustainable activities. This information may also include the positive environmental/social impact resulting from such activities. Part D Reporting to the Authority (Bi-annual basis) Classification Reporting Period Cumulative in FY (USD mn) Medium/ Long term (USD mn) Short term loans (USD mn) Trade Finance Working Capital / Supply Chain Finance Others Green