ESG – Examining the 'S' in ESG in the context of 'Social Loans'

In-depth analysis

As focus escalates on the need for organisations to operate in a more sustainable manner, and in particular, to become net-zero by 2050, more and more attention is being paid to ESG factors. Businesses are increasingly looking for ways to make their operations more ESG compliant; a process which involves grappling with the parameters of each contingent part in order to set internal targets. External factors also influence the growing focus on ESG: the regulatory landscape around ESG is growing at pace, and lenders are placing a much greater significance on the ESG profile of potential borrowers, with the aim of promoting sustainable business practices.

When thinking about the best way to implement ESG initiatives and analyse their success, it is arguably much easier to quantify and therefore tackle the 'environmental' aspects of ESG as compared to the slightly less easy to define 'social' element. This article will consider the key points businesses and stakeholders need to be aware of in relation to the 'social' element of ESG and ways in which businesses can identify opportunities for 'Social' initiatives, quantify those opportunities, take action to address them and measure the outcomes.

Within the finance sphere, 'social initiatives' are a key concern for every party involved in a financing including borrowers, lenders, sponsors, stakeholders, asset managers and insurers, in particular in real estate financings where the development of real estate can have a significant effect on local communities. Understanding the 'S' in ESG assists us in determining how lenders and borrowers can work together with a view to meeting their social responsibility goals and to put in place loans that meet the recommended voluntary guidance for 'Social Loans', as applied to the particular transaction, produced by the Loan Market Association (LMA), the Loan Syndications and Trading Association (the LSTA) and the Asia Pacific Loan Market Association (the APLMA). We look further at this guidance in terms of how metrics may be chosen to report on the social impact of projects and how this can assist us in the difficult task of quantifying their outcomes.

Environmental versus Social considerations

It is arguable that the environmental part of ESG is the simplest to identify, quantify, measure and standardise, particularly in terms of considering the direct impact the actions of an individual business have on the environment around them. A business can be assessed in terms of its carbon footprint, net-zero initiatives, emissions generated from its everyday operations and ability to access sustainability linked or green loans. Real estate can be assessed by its EPC ratings, BREEAM certification, compliance with environmental regulations and the carbon footprint of the relevant building/s.

In comparison, whilst businesses may be able to identify some areas of need relating to the 'social' element of ESG, it can be significantly harder to quantify and measure the results or impact those initiatives are having on the 'social' landscape. A different style of analysis is likely to be required compared to that in relation to environmental objectives.

So, what does the 'S' actually mean?

Addressing the social element of ESG involves a focus on the human obligations of a business, and the putting in place of strategies that impact people in a positive way and provide clear benefits of a social nature. The general concept considers that it is imperative to find a balance between profitability and the benefits a business can deliver to those around it. Whilst this concept is wide, a helpful starting point can be to consider the ways in which the specific company or business interacts with its employees and surrounding communities. The factors relevant to individual businesses will vary according to their scope and operations and will need to be considered on a business-by-business basis.

Organisations in this jurisdiction are subject to a raft of legislation in relation to human rights, modern slavery, anti-bribery and employee rights which they must adhere to in performing their operations. However, when considering how a specific organisation can be more ESG compliant, particularly on an international scale, ISO 26000 (ISO), produced by the International Organisation for Standardisation, is a helpful standard containing voluntary guidance that can be used to quantify organisation specific social responsibilities. It covers seven key principles in relation to social responsibility: accountability, transparency, ethical behaviour, respect for stakeholder interests, respect for the rule of law, respect for international norms of behaviour and respect for human rights.

……and what is a 'Social Loan'?

The LMA, LSTA and APLMA updated their voluntary recommended guidelines and supporting guidance for sustainable finance on 23 February 2023, including in relation to loans in the social loan market (Social Loans). The guidelines are to be applied on a deal-by-deal basis, and their application will depend on the underlying characteristics of the transaction. The LMA's Social Loan Principles, (the SLP), referred to Social Loans, as "any type of loan instruments and/or contingent facilities (such as bonding lines, guarantee lines or letters of credit) made available exclusively to finance, re-finance or guarantee, in whole or in part, new and/or existing eligible Social Projects, and which are aligned to the four core components of the SLP." All loans originated, extended or refinanced after 9 March 2023 must be fully aligned with the SLP dated February 2023, to be classified as Social Loans.
A set of four criteria is established by the principles:

Use of the loan proceeds for 'Social Projects': designated Social Projects are required to provide clear benefits of a social nature. Indicative, non-exhaustive examples of such projects given by the SLP are (1) affordable basic infrastructure; (2) access to essential services; (3) affordable housing; (4) employment generation and programs designed to prevent and/or alleviate unemployment; (5) food security and sustainable food systems; and (6) socioeconomic advancement and empowerment. The projects may be aimed at, but not necessarily limited to a 'target population', and indicative examples of this given by the SLP include people living below the poverty line, excluded and/or marginalised communities and people with disabilities. The guidance that accompanies the SLP (the SLP Guidance) states that there is "no consensus in relation to what constitutes 'social' in the context of Social Loans". It does however refer to a number of standards that may be helpful in interpreting this such as the World Bank's Environmental and Social Standards and the UN's Sustainable Development Goals.
Process for project evaluation and selection: the borrower of a Social Loan should clearly communicate to the lenders the social objective and target population of the Social Project; the process by which the borrower determines that the project will fit within the Social Loan criteria and complementary information showing how the borrower manages the risks associated with the relevant project.
Management of proceeds: the proceeds should be credited to a dedicated account or tracked by the borrower in an appropriate manner.
Reporting: the borrower should maintain readily available, up to date information on the use of proceeds and review such information annually until the Social Loan is fully drawn. The report should include a list of the projects to which the loan proceeds have been allocated and include their expected, and where possible, achieved impact.

How can we quantify the success of a social initiative and particularly a Social Loan?

Given the 'S' is a people focussed concept, when considering the success of any social initiative, businesses need to analyse it in both a quantitative and qualitative way. This contrasts with the analysis of environmental initiatives, where the relevant comparators will often be reviewed using metrics, measurements and readings.

Qualitative analysis of the impact social initiatives have had is likely to involve the consideration of a broad range of data from which patterns and inferences may be drawn, and a framework drawn up setting out the outcomes understood from that data.

Quantitative analysis will also be relevant in measuring this impact; businesses can consider fiscal and economic outcomes directly created by the initiative, for example:

increases in the level of employment opportunities
increased accessibility to that employment or profession for those in the local community (or perhaps nationally)
a rise in the skills employees have and/or are able to develop in their employment
the introduction of equal pay initiatives
any increase / decrease in efficiency.

In the context of Social Loans, when quantifying the "social impactor efficiency of projects", the SLP and SLP Guidance are extremely helpful:

They note the importance of transparency in communicating the expected and where possible achieved impact of projects and suggest where borrowers can, they should include information on the 'achieved impact' of the Social Project in their annual report.
The SLP Guidance recommends "the use of qualitative performance indicators and, where feasible, quantitative performance measures and disclosure of the key underlying methodology and/or assumptions used in the quantitative determination." In the absence of commonly accepted standards in an area, borrowers are encouraged to use their own methodology, with transparency on the accounting methodology and assumptions they have applied recommended. The drawbacks of this approach. which does not involve working to a standardised methodology, are noted. It is suggested that parties refer to market guidance in this area, for example ICMA's harmonised Framework for Impact Reporting for Social Bonds dated June 2022.
Borrowers are encouraged to have a process in place to identify mitigants to known or potential material risks of negative social and/or environmental impacts from the relevant project(s).
An external review provider may be appointed by a borrower to assess the alignment of the Social Loan with the SLP.

Why is it important to Lenders that Borrowers meet the targets of their social initiatives?

Lenders and borrowers will want to ensure that the borrower is meeting its social initiatives, including those to which a Social Loan relates for a number of reasons:

It is recommended by the SLP and SLP Guidance as part of the reporting process in relation to a Social Loan.
A borrower with violations of a 'social' nature may face costly litigation for such violations, impacting cash flow of the business and thus the ability to maintain their financial obligations under a loan, plus damage to that business' reputation.
Lenders need to consider the reputational impact any involvement with an offending borrower or building development may have plus the potential impact of failing to actively participate in the societal shift to increase social benefit. Equally, actively engaging with and ensuring compliance initiatives are successful can have strategic importance and can create great reputational benefits for lenders within the market.

Applying the criteria to actual Social Loan projects

Social loans can be seen in the form of development projects that include affordable housing initiatives, projects or buildings that pride themselves on inclusive workspaces, student living that prioritises student mental health and wellbeing, or through specific social initiatives by individual companies.
When assessing a particular real estate project in terms of its 'sociaL' impact, it is important to consider all of the ways in which the building or development impacts the community around it. Relevant factors may be the impact a new building has on the landscape, the impact the building work has on the lives of people within the community and the impact generally of a new building within the community. Negative impacts may include objections to the project, and disruptions to the obtaining of planning permission, with costs being incurred both in terms of money and social impact before the project has properly started.

Giving due focus at the outset to the impact the development will have on the community, and to the building of a framework to encourage engagement from and transparency with the local community not only benefits ESG efforts but also can benefit the success of a project in the long run. All of these considerations are particularly important as purpose-built student accommodation and student housing continue to be a key focus and driver of growth in the real estate sector following Covid-19.

Concluding thoughts

Organisations must ensure that the social benefit in the work that they do is at the forefront of their objectives. In financings, both in terms of aiming to meet with the SLP and generally, it is important that borrowers use appropriate mechanisms to measure and report the work they are doing to ensure social benefit and community engagement in their work. Lenders must ensure they request as much ESG compliance information as possible to not only encourage borrowers to hold ESG as a priority and to deliver on their Social Projects, but also to reduce any concerns around risk profile or reputational damage by lack of compliance.