Banks and other corporations have been exploring green financing as a way to implement ESG business projects. Green loans and sustainability-linked loans (“SLLs”) are the major types of such financing. The former require the use of borrowed proceeds for green purposes only, such as the purchase of solar panels, while SLLs can be used for any purposes, though the interest rate will adjust depending on whether the corporate borrower meets pre-agreed ESG targets.
The labels “green loans” and “SLLs” both signal ESG commitment, but they are governed by different guidelines, which are the Green Loan Principles and the Sustainability-Linked Loan Principles. Although these principles are voluntary, they carry weight because they are issued jointly by the “authoritative voice[s]”, which include the Loan Market Association (LMA), Asia Pacific Loan Market Association (APLMA), and Loan Syndications & Trading Association (LSTA).[1]
In a new paper, I focus on the Green Loan Principles (the “Principles”) and examine the formulation of the “green” threshold. While the definition of “green” may seem ambiguous, its flexibility serves important functions.
Adopting a taxonomical approach for determining whether a project is green, the Principles currently list several broad and non-exhaustive categories of eligibility for Green Projects which contribute to environmental objectives such as climate change mitigation, and pollution prevention.[2]
Being Categorically Green Suffices
A project is green under the Principles if it fits one of the listed categories. This approach could, however, overlook how the green nature of a project sometimes cannot be solely determined by its type or category, but instead depends on the manner of subsequent execution. For example, electric vehicles (“EVs”) have lower net emissions than gas fueled counterparts only if they are used often enough because EVs are “dirtier to build but cleaner to drive.”[3]
Another example of a green loan-funded project is the purchase of land for use as forest. The green land absorbs atmospheric carbon, and is known as a type of carbon sink. But this means its green nature depends entirely on its use and is negated if it is converted into a non-green purpose.
The EV and the forestry projects fit under the Principles’ suggested categories of “clean transportation” and “environmentally sustainable forestry,” respectively. Accordingly, they pass the green threshold. The green loan is contractually dedicated to the acquisition of a green asset, and the proceeds have been used accordingly. The Principles’ classification is done categorically at the time of making the green loan rather than later when the green asset or project is developed.
I argue that this categorical approach has several market-friendly and important advantages.
One Upside
Declassification – ceasing to use the “green loan” label – may not be enough to deter green-to-ungreen conversion if doing so brings a higher financial return (e.g., selling the acquired green land for industrial purposes when property price goes up).
Declassification is the only major consequence under the framework, and the “failure to comply with such ‘green’ covenants by the borrowers would not result in an event of default.”[4] In effect, this gives the borrower the flexibility to either comply with the requirements of the green loan for reputational gain or convert the green use for financial gain.
Another Upside
There are situations where a project becomes un-green without any conversion, disposal, or other act by the borrower. It could be caused by an externality, or an omission or inability to act on the part of the borrower to maintain the green nature of the project. For example, a green asset (like an EV for business use), prior to reaching carbon neutrality, could become idle or obsolete due to the inability to repair it.
Imagine that a green loan has a contractual duration of about a decade for implementation and repayment. Many disruptive changes could occur during this period. For example, hydro power could become unfeasible and unsustainable if there is a drought. If the energy output from renewable sources does not justify its environmental cost of implementation (e.g., cutting trees to build the dam), then it is difficult to argue that it is still green.
The Principles’ categorical approach looks at the original nature of the project. This avoids the need to deal with these risks of material changes that are beyond the control of the parties.
Simplicity and Openness
There are many projects whose green nature is debatable. For instance, the Green Loan Principles list “renewable energy” as an acceptable green project. But scholars have argued that hydropower, despite being renewable, “diverts waterways and negatively impacts the environment, can hardly be named ‘green.’”[5]
The Principles do not distinguish between either “green” and “renewable” energy or “green” and “sustainable.” These terms overlap but have subtle differences. But by using them interchangeably in the Principles, the notion of “green” embraces all of them. Such a broad conception of green-ness not only avoids debates, but also has the upside of allowing the market to pursue more and different projects.
Conclusion
Determining what qualifies as “green” involves balancing the goals of (1) preserving commercial freedom, (2) supporting ESG transitions, (3) preventing greenwashing, and (4) maintaining the reputation and integrity of green loans. At the same time, it is difficult to account for constantly evolving green technologies and complex social expectations for ESG and green-ness. The Principles capably address these challenges by adopting broad categories for eligible green projects. As a governance framework, it offers more transparency about green loans, which facilitates itsusefulness.
ENDNOTES
[1] PwC, Accounting for Green Loans (Apr. 2023), at 3, https://www.pwc.com/id/en/publications/assurance/accounting-for-green-loans-2023.pdf
[2] Asia Pac. Loan Mkt. Ass’n, Loan Mkt. Assoc., & Loan Syndications & Trading Ass’n, Green Loan Principles(2025).
[3] Christy DeSmith, You Bought an Electric Car. Why Did Your Carbon Footprint Grow?, Harv. Gazette (Aug. 28, 2023), https://news.harvard.edu/gazette/story/2023/08/when-buying-an-ev-increases-your-carbon-footprint/.
[4] Rajah & Tann Asia, A Guide to Sustainable Financing in Southeast Asia (Aug. 6, 2021), at 5, https://www.lexology.com/library/detail.aspx?g=60772bfe-9b4f-4adf-9913-f93d0121f335
[5] Armenia Androniceanu & Oana Matilda Sabie, Overview of Green Energy as a Real Strategic Option for Sustainable Development, 15 Energies 2022, at 2-3.
This post comes to us from Yat-cheung Kwan at the University of Hong Kong’s Asian Institute of International Financial Law and Monash Business School’s Centre for Development Economics and Sustainability. It is based on his recent paper, “ESG’s Green Loans and the governing Green Loan Principles,” available here.