Insights

Green lending in the hotels, hospitality and leisure sector

Sustainable finance regulation

Ben Parish

All industries are facing pressure to meet the UK Government’s target, agreed at the COP28 summit in Dubai, of achieving “net zero” by 2050, but the hospitality industry has arguably been ahead of the curve. The industry body UK Hospitality published its “Roadmap to net zero” in 2022, which set out a plan to achieve “net zero” by 2040, ten years ahead of the Government’s already ambitious target. Changes in expectations from customers as well as the developing political agenda mean that the hotels, hospitality and leisure (HHL) sector is considering climate change and environmental targets more urgently. Banks are also playing a role in the net zero transition with most major UK banks having adopted “green” finance targets. As a result, green or sustainably linked loans are becoming increasingly common, and this article considers their application to hotels, hospitality and leisure.

Green and Sustainability-linked Loans

There are two main “green” lending products available in the market, green loans and sustainability-linked loans, and the Loan Market Association (LMA) has provided a framework of principles for both.

A “green loan” is any loan or debt instrument which is used to finance, refinance or guarantee new or existing green projects. According to the LMA’s “Green Loan Principles”, green projects include the expected array of green energy, clean transportation and pollution prevention projects but, crucially for the HHL sector, they also include green buildings. Green buildings are any building which meet regional, national or international standards or certifications for environmental performance. A building’s energy performance certificate (EPC) or Building Research Establishment Environmental Assessment Methodology rating (Breeam) are the most referenced set of standards. An EPC rating of “A” or a Breeam rating of “Excellent” are good indications that the financing or refinancing of such a building would qualify as a green project, although each lender will have its own policies for assessing whether a project meets its requirements.

Sustainability-linked loans do not necessarily need to fund a green project but will usually contain pre-agreed sustainability performance targets which the borrower will be encouraged to meet. Sustainability performance targets can be environmental or non-environmental and can include, for example, a reduction in greenhouse gas emissions and energy consumption, water quality targets, the payment of a living wage to all staff and contractors and the reduction of food waste.

Benefits and drawbacks

Lower borrowing costs

The main benefit from a borrower’s perspective is that banks will usually offer a lower margin on any green loan or sustainability-linked loan where the borrower has met the sustainability performance targets. Developers of new or renovated hotel and hospitality properties may have built energy efficiency and sustainability into the designs to lower running costs or for other reasons and may therefore find that cheaper green or sustainability-linked financing is available with limited impact on their planning.

The financial advantage may be limited where the improvements to the EPC or Breeam rating of a property form only part of wider renovation work. The LMA’s Green Loan Principles suggest that lenders should segregate lending for a green project from lending which has other purposes, with the lower margin only applying to the “green” part of the loan. The lender may also want more control over the proceeds of a green loan and may require the proceeds to be paid to a segregated account with withdrawals monitored to ensure the proceeds are solely used for the stated green purpose.

While breaches of any of the new provisions included as a result of the classification of a loan as green or sustainability-linked will not usually trigger an event of default (as would a breach of any other provision), this would likely trigger de-classification of the loan and a consequential increase in the margin, leaving the borrower with the additional reporting requirements referred to below with no corresponding financial benefit.

Brand reputation

There may also be public relations benefits for the borrower and the lender of promoting the environmental credentials of, respectively, their assets and the assets they’re financing. Hotels and hospitality venues may see value in marketing to customers that they are funded through green or sustainable financing and how this reinforces their commitment to reducing their environmental impact. Lenders can tell investors that they are reducing the environmental impact their businesses indirectly and meeting evolving market expectations.

Administrative burden and impractical targets

Both green loans and sustainability-linked loans will have additional reporting requirements and borrowers should consider the administrative burden of complying with these alongside the financial benefits. The achievability of any sustainability-linked performance targets is also an important consideration; the borrower needs to ensure it has a good chance of meeting them and achieving the lower margin on offer. Given the number of suppliers hospitality businesses typically have, especially hotels, thought should be given to any requirements involving third party suppliers and contractors, the extent of any targets relating to them and the borrower’s ability to control the required outcomes. The same issue may arise on “design and build” development financings where a third-party building contractor will appoint sub-contractors and consultants, and the property owner will have less day-to-day control of the project.

Conclusion

Investors and customers have prioritised the environmental and sustainability credentials of HHL businesses. The industry’s progress on this front and its plans for the next 15 years mean it is well positioned to benefit from the expansion of green financing and the perks offered by banks. While borrowers should consider the additional burdens they will face, these products may offer financial and public relations advantages.

How we can help

Our BankingFinancial Services and Insolvency teams regularly act for lenders offering green financing and we also act for hotels, hospitality and leisure clients across the sector on their banking and finance needs. If you have any questions regarding green or sustainable finance or any of the loan products discussed above, we are experienced in these matters and can offer practical and sensible advice.

This publication is a general summary of the law. It should not replace legal advice tailored to your specific circumstances.

© Farrer & Co LLP, October 2024

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