ESG issues in mining finance transactions

With the pledges on climate change made by the representative nations at the recent G7 summit in Cornwall and various financial institutions increasingly making 'green' financing available to corporates in jurisdictions with a heavy mining presence, environmental, social and corporate governance (ESG) is a hot topic for the mining industry.

Mining transactions are increasingly adherent to various ESG principles to satisfy lenders, partners and customers as well as to preserve their social licence to operate.

In this article, we provide a brief overview of the different ESG principles relevant to funders and mining companies and take a deeper dive into how to incorporate those principles into agreements documenting loan facilities and other financial instruments.

Overview of the different ESG principles relevant to mining companies

For financing purposes, there are five key sets of principles which are relevant to mining companies (the first three being general principles developed by the Loan Market Association and the last two being principles more industry specific to mining).

We set out a brief overview of these below:

Green Loan Principles (GLPs)

The GLPs are tied to the specific use of a loan and its proceeds. For a loan to be categorised as a 'Green Loan' under the GLPs it needs to meet four core criteria. These are:

1. Use of Proceeds: the loan must be utilised for green projects that provide clear environmental benefits.
2. Process for Project Evaluation and Selection: the borrower should make it clear to lenders the process by which it determines how its projects fit within the acceptable categories of green project, and the eligibility criteria applied.
3. Management of Proceeds: to maintain transparency as to how they are applied, the proceeds of a loan should be credited to a dedicated account (or equivalent process).
4. Reporting: borrowers should maintain up to date records on the use of proceeds and where possible, to report on achieved impacts.

 

Sustainability Linked Loan Principles (SLLPs)

The SLLPs seek to encourage "good behaviour" from borrowers by tying, for example, the pricing of a loan product to the achievement of particular sustainability performance targets (‘SPT’), which may be contained as covenants or undertakings in a loan agreement. The four key principles are as follows:

1. Relationship to Borrower’s Overall CSR Strategy: the borrower should clearly communicate to the lenders its sustainability objectives as set out in its ESG strategy and how these align with the SPT (to which the loan is linked).
2. Target Setting – Measuring the Sustainability of the Borrower: the SPT should be ambitious and meaningful to the borrower’s business. As a condition precedent to completion, third party opinions may be sought as to the appropriateness of the SPTs.
3. Reporting:  borrowers should maintain up to date records on their SPTs and provide these to the lenders at least once every year.  Public reporting is encouraged to facilitate transparency.
4. Review: for publicly traded companies, lenders may be comfortable relying on the borrower’s public disclosures to verify its performance.  Otherwise, borrowers may be required to seek external review of its performance.

 

Social Loan Principles (SLPs)

Much like the GLPs, these are tied to the specific use of the loan and its proceeds. The core criteria are the same as for the GLPS, i.e. Use of Proceeds; Project Evaluation and Selection; Management of Proceeds; and Reporting, but the focus here is to fund social projects that directly aim to address or mitigate a specific social issue and/or seek to achieve positive social outcomes especially, but not exclusively, for a target population(s).

Equator Principles

Rather than being general principles developed by the Loan Market Association (as is the case with GLPs, SLLPs and SLPs), the Equator Principles are intended to be specific to those entities operating in the project finance space and, as such, are directly relevant to mining companies.

Operating as a risk management framework by financial institutions for determining, assessing and managing ESG risks in a project, the Equator Principles seek to provide a minimum standard for due diligence and monitoring to aid responsible decision making. They are a set of ten social and environmental principles covering matters such as environmental standards, stakeholder engagement and reporting, and transparency, which must be met by borrowers in order for participating financial institutions (currently 116 in 37 countries) to advance funds.

Mining Principles

The Mining Principles are drawn up by the International Council on Mining & Metals (ICMM) and define the good practice ESG requirements of company members through a comprehensive set of 38 Performance Expectations (covering principles such as ethical business, environmental performance and conservation of biodiversity) and eight related position statements on a number of critical industry challenges (such as climate change and transparency of mineral revenues).

The Mining Principles are an important industry barometer in the sense that members of the ICMM (which currently comprises 27 mining and metals companies, including Rio Tinto, Anglo American, Glencore and BHP, and over 35 associations in more than 50 countries) are expected to adhere to the Mining Principles as a condition of membership.

Whilst the Equator Principles are primarily aimed at lenders in the project finance space, the Mining Principles can be viewed as the industry standard principles for mining companies to adopt.

Applying the principles – specific clauses to adopt in your documents

Implementing the broad principles above can be achieved through changes to the functioning of the business and putting policies in place that ensure operations adhere to those principles throughout the life cycle of a mine or the operations of a mining company.

However, when it comes to documenting the financing itself, there are a number of specific clauses that can be included.  An approach commonly taken is to reference a set of principles, such as the Equator Principles, in the representations, warranties and covenants of the agreement to ensure broad general compliance by the borrower.

Model clauses

In addition to making reference to a set of principles, a set of clauses has been produced by The Chancery Lane Project - a collaborative effort by lawyers to develop new contracts and model laws to help fight climate change - in their latest Climate Contract Playbook (the "Playbook"), which can be included in the transaction documents.

There are three specific sets of clauses from the Playbook that focus on green and sustainable lending in finance:

1. Sustainability-Linked Loans;
2. Climate Standard Transaction Terms; and
3. Green Loan "Starter Pack".

Our focus in this section of the article is on the "Sustainability-Linked Loans" and the "Climate Standard Transaction Terms" clauses, as these are more likely to be of use in the mining sector in conjunction with the Sustainability Linked Loan Principles outlined above, and which may be easier to adopt in the mining context.

The "Green Loan Starter Pack" set of clauses are applicable where the loan proceeds are used for green purposes only i.e. the proceeds will have a demonstrably positive environmental impact. In the mining industry, this could be where the proceeds are utilised to adopt different methods of extraction to reduce the environmental footprint of operations.

The clauses discussed here were drafted with existing market precedents in mind, such as the Loan Market Association's suite of documents. Note that they are designed to be a starting point for negotiations, and will therefore need to be tailored to the specific transaction.

Sustainability-Linked Loans

This set of clauses is designed to accommodate the SLLPs into loans and other financial instruments. In the mining context, this is where the loan itself is used for general corporate and/or operational purposes.

Targets and milestones

Specific facilities and/or tranches are designated as sustainability linked facilities under which the relevant sustainability linked borrower undertakes to achieve its sustainability performance targets (targets that can be set out in a schedule and agreed between the parties).

Examples of targets that can be included in a mining context are:

1. improvements in the energy efficiency rating of buildings and/or machinery;
2. increases in the amount of renewable energy generated or used by the borrower; and
3. improvements in conservation and protection of biodiversity.

Targets are tested on an agreed test date (quarterly, as drafted) and the borrower submits a compliance certificate following each test date in respect of the performance targets that have been set.

Depending on whether the targets are met, the margin for the loan will ratchet up or down by a percentage to be determined by the parties.  Note here that, under the current drafting, each sustainability compliance certificate is made available for public access on the website of the sustainability-linked borrower.

Disclosure requirements

It is becoming increasingly common that companies are expected to disclose the actions they are taking to combat climate change, but the obligation to publish the compliance certificate puts a specific document prepared in connection with the loan agreement into the public domain. Borrowers will need to discuss the extent to which the information they are willing or able to disclose in the compliance certificate at the drafting stage.

Strong borrowers may, for example, insist they are permitted to provide information of mitigating circumstances or make certain representations in the compliance certificate if they have failed to meet the performance targets.

There is also the potential to include a condition subsequent to oblige the borrower to publish its sustainability strategy and its performance targets soon after the agreement has been signed. Again, this is becoming increasingly standard across all industries.

Events of default

It is a specific event of default if a sustainability-linked borrower does not achieve a certain (negotiated) percentage threshold of its performance targets and if it does not provide a sustainability compliance certificate. Grace periods may be considered by borrowers though will be resisted by lenders given the specific targets and timing of the delivery of the compliance certificate will be negotiated up front.

Conclusion

Negotiation of these clauses will centre around what shape the sustainability performance targets and sustainability strategy take, when testing of those targets will occur and the relative increases and decreases in the margin to reflect the achievement (or not) of targets. Certain borrowers may also push to be allowed to consult with the Sustainability Coordinator and Sustainability Experts while the decision as to whether performance targets are achieved is being made.

Climate Standard Transaction Terms

Like with the Sustainability-Linked Loans clauses, the Climate Standard Transaction Terms may also be adopted in furtherance of the SLLPs.  There are, for example, sustainability goals (including moving to a renewable energy provider and creating KPIs to measure the company's impact of its operations) that the company must adopt and which are reviewed on a quarterly basis by the board.

However, there are two key differences: (1) the clauses have been drafted on the basis for use in project finance transactions to aid impact investment in emerging markets align with the Paris Agreement (and therefore local law considerations also need to be taken into account), and (2) there is greater emphasis on specifically reducing the carbon emissions of the company.

Sustainability goals

The proposed drafting framework provides for specific sustainability goals to be adopted and maintained including (among others) development of a carbon neutral plan, achievement of pre-agreed reductions in the company's carbon footprint, and a review of all supplier terms to ensure goods and services are procured from companies that have net zero targets.  A member of the board of the company must be appointed as the company's Chief Sustainability Officer (CSO) who has oversight of sustainable expense and travel approval.

"Carbon neutral plan", "carbon footprint" and "net zero targets" are all terms defined in the agreement by reference to technical definitions of carbon dioxide, greenhouse gases and the GHG protocol – the current GHG Protocol Corporate Accounting and Reporting Standard produced by the World Resources Institute and the World Business Council for Sustainable Development.

It is clear, then, that under the proposed drafting the borrower must take a proactive role in managing its project sustainably and not merely ascribe to a set of broad principles.

Eligible transactions

In addition to committing to reduce its carbon footprint across its business and the operation of the project, the company must also apply the proceeds of the loan exclusively towards an "eligible transaction" i.e.:

1. an investment that will be (a) aligned with the mitigation goals of the Paris Agreement and (b) does not undermine the nationally determined contributions of a country to reduce emissions under the Paris Agreement; and
2. a transaction that is permitted under the lender's climate change standard (which can be appended as a schedule).

If this clause is included in a mining transaction, consideration must therefore be given to whether the proceeds can be used for such an eligible transaction in the context of the project.

Covenants and compliance

Ongoing covenants relating to compliance with sustainability goals, the climate change standard and maintenance of a CSO can be included and various climate-orientated events of default can also be included such as:

1. if there is a breach of the climate standard terms; and
2. if the lender considers that a Material Climate Breach has occurred.

The climate standard terms will commonly be those terms of the lender it determines are necessary for its counterparties to adhere to in order to operate sustainably. A Material Climate Breach encompasses a wider pool of potential triggers: (i) if monies are used for any transaction that is not an Eligible Transaction; (ii) the company's carbon footprint increases; (iii) the carbon neutral date is missed; and/or (iv) any action is taken that is contrary to the sustainability goals.

Conclusion

The drafting that can be adopted from this set of clauses is clearly robust and comprehensive. The extent to which counterparties can be encouraged to conduct their business in a sustainable manner extends to every aspect of the transaction – there is even a suggested notices clause that provides for sustainable methods of giving notice, for example that the parties only use recycled paper and non-solvent based ink when printing a notice.

The intention is clear: to provide a full framework for sustainable financing. This means the onus is on the counterparties, in particular the borrower, to ensure they are complying with these stringent measures.  The various emission reduction targets that are set in each relevant country where a counterparty conducts its business, as well the company's own operational structure, will have to be taken into consideration in order to set effective sustainability goals and ensure they are complied with.

Executive summary

The Playbook clauses and applicable definitions are granular in detail and actively seek to tie the relevant parties to specific action on climate change in order to meet part of the UK’s Green Finance Strategy to transform financial services by "moving beyond just funding green projects to ensuring climate and environmental factors are fully integrated into mainstream financial decision making across all sectors and asset classes."

Counterparties will have to adapt the provisions to each specific transaction, but they provide a useful framework from which to start in order to begin applying the broader principles that should be of concern to those financing or seeking financial backing in the mining sector.

For any further information or questions arising as a result of the points discussed in this article please speak to Oliver Abel Smith, Philip Abbott, Anna Crosby, Sebastian Crawford or email FMPSustainabilityGroupEurope@fieldfisher.com