Sustainability-linked loans and the SPPI test

What is the SPPI test?

IFRS 9 classifies a financial asset at amortised cost if it is held to collect contractual cash flows and those cash flows are solely payments of principal and interest. Interest must be consideration for the time value of money, credit risk, other basic lending risks such as liquidity, costs, and a profit margin. Features that introduce exposure to unrelated risks, such as equity prices or commodity prices, fail the test. See IFRS 9 classification.

How do the 2024 amendments treat ESG-linked features?

The amendments say a company assesses the contractual cash flows that could arise both before and after the change in cash flows caused by a contingent event. If the nature of the event is not directly related to changes in basic lending risks and costs, such as a borrower meeting an emissions target, the instrument passes only if the cash flows in all contractually possible scenarios are not significantly different from those of a financial instrument with identical terms but without the contingent feature. The event's nature alone does not decide the outcome; the size of the possible change and what it is linked to do. The amendments include examples, such as an interest rate that adjusts by a specified number of basis points if the borrower meets a carbon reduction target.

What does not significantly different mean?

IFRS 9 does not set a numerical threshold, so lenders apply judgement, usually comparing the contractual cash flows of the loan with and without the feature in each possible scenario, including the maximum adjustment. The comparison can be made on the interest rate, the annual cash flows or the total undiscounted cash flows, applied consistently and documented in an accounting policy. Features whose effect could only ever be small, so-called de minimis features, do not affect classification. See the effective interest method.

The SPPI test in practice: two sustainability-linked loans

A bank assesses two five-year loans of EUR 100 million at a reference rate plus 2.00%.

Loan A's margin moves by 5 basis points for each of 3 borrower-specific targets, so it can range between 1.85% and 2.15%. The largest possible change in total contractual interest over five years is EUR 0.75 million on EUR 100 million of principal, which the bank judges not significantly different, so the loan passes and is measured at amortised cost. Loan B's margin moves with a published carbon price index, a market variable unrelated to lending risk, so it fails, and the bank measures it at fair value through profit or loss. See green bonds and sustainability-linked loans for the borrower's side.

What happens if a loan fails the SPPI test?

It is measured at fair value through profit or loss, whatever the business model, so its value moves with interest rates, credit spreads and the linked variable, creating volatility. It is outside the expected credit loss model, because credit risk is already in fair value. Banks often design their sustainability-linked products to pass the test, with small, borrower-specific ratchets. See IFRS 9 expected credit loss.

What must lenders disclose?

For each class of financial assets measured at amortised cost or at fair value through other comprehensive income, and each class of financial liabilities at amortised cost, IFRS 7 now requires a qualitative description of the contingent events, quantitative information about the possible changes in contractual cash flows, such as the range of possible changes in interest rates, and the gross carrying amount of the assets, or amortised cost of the liabilities, subject to those terms. The disclosures apply even where features do not make cash flows significantly different. See IFRS 7 disclosures.

How do the amendments apply on transition?

They apply retrospectively from the start of the first annual period beginning on or after 1 January 2026, without a requirement to restate comparatives; any reclassification adjusts opening retained earnings and is disclosed. Early application was permitted, subject to local endorsement. Lenders should review existing sustainability-linked loans, especially those classified at fair value under earlier, more cautious policies. See climate risk in expected credit losses.

This guide is general information. It is not tax or legal advice for your situation.