FCA sees better practice, tighter standards in sustainability-linked loans

The sustainability-linked loan (SLL) market continues to mature on the back of tighter industry standards and guidance, according to the latest letter from the UK Financial Conduct Authority (FCA) on August 14.

SLLs are credit instruments designed to incentivise borrowers to pursue environmental goals. Increasingly, they are used as tools for businesses to transition to more sustainable practices. The global market for SLLs peaked at $610 billion in 2021, and recorded $463 billion in issuance in 2024, according to the Loan Market Association (LMA).

In 2023, the FCA conducted a review of the SLL market, identifying weaknesses in market integrity, credibility, incentives and conflicts of interest. Following its industry engagement this year, the UK regulator found that despite “barriers to scaling” in the past two years, banks remain active in the SLL market.

For example, some banks started classifying SLLs within their sustainable financing targets and published frameworks outlining when SLLs may be eligible. “We have observed some banks including SLLs in their targets by default. By contrast, some have eligibility criteria based on features of a borrower, while others apply exclusions based on a list of predetermined activities, sectors or other characteristics,” said the FCA.

While the decision to include SLLs in sustainable financing targets remains voluntary, the FCA strongly supports the practice. It warns that failure to clearly articulate how fitting SLLs into targets could expose banks to reputational risk and diminish trust in their sustainable products.

SLL sanctions

The FCA gave banksʼ use of declassification as a sanction as an example of emerging best practice. It found cases where banks declassified an SLL when a borrower breached the sustainability-linked terms of the loan agreement or when the loan no longer met the bankʼs criteria.

The regulator previously raised concerns over “potential risks to market integrity and suspicion of greenwashing” in its 2023 review, which highlighted cases of misalignment between borrowers’ published transition plans and their disclosures.

Meanwhile, in its 2025 review, the FCA said: “The fact that banks are now prepared to declassify SLLs tells us that standards have been raised, and banks are willing to exert the full range of measures to maintain higher standards.”

Tighter principles

However, the FCA noted that “clarity around frameworks and targets” is still important for the SLL market. It added that many banks cite the LMAʼs revised Sustainability-Linked Loan Principles (SLLPs) as having “raised baseline standards”.

In its 2023 principles, the LMA previously included a “grandfathering” language for transactions completed prior to the announcement, which exempted them from having to comply with the new principles. However, the 2025 SLLPs removed this language as it was “a source of uncertainty” for the market, said the LMA.

The 2025 principles also focused on distinguishing mandatory requirements, recommendations and options. One example is the criteria for key performance indicators (KPIs) and sustainability performance targets (SPTs): KPIs are now required to “be consistent with the borrower’s overall sustainability strategy” and “externally verifiable where feasible”.

The LMA’s principles aligns with the FCA’s monitoring, as multiple parties now scrutinise KPIs and SPTs more closely during SLL structuring, contributing to stronger alignment with the borrower’s business model, according to the FCA.