Green finance is now playing a pivotal role in the race to net zero for buildings – it’s fair to say, in fact, that we won’t be able to achieve net zero in the built environment without it. As well as wanting to be socially responsible, lenders and investors are acutely aware that green buildings mitigate their risk and create better long-term value. Green buildings will be more marketable in future and are designed to be resilient to the damaging effects of climate change. Financiers are also very aware that buildings that don’t put green at the forefront could become ‘stranded’ assets in future. As legislation becomes more stringent, poorly performing buildings could become unlettable or unusable in future.

This has led to most lenders and investors now creating strong ESG agendas, developing dedicated sustainability teams to help meet climate challenges and put together new forms of finance that puts green at the forefront.

‘Green Finance’ is now a well-used term referring to a loan or a bond that is marketed or drafted specifically to be environmentally friendly, but what forms does this take?

In our previous blog, we looked at the typical challenges investors face when trying to lend into the green building market. Today, we will delve into what green finance actually is and how it can be used for buildings.

Put simply, green finance either entails proceeds being used to fund green projects or an income stream being generated by green assets. It typically comes in two main forms: green loans and green bonds.

Green Loans

Green loans are any type of loan instrument made available to finance new or existing green projects. These projects should provide clear environmental benefits, which need to be initially quantified and assessed, then measured and reported on by the borrower. Lenders are increasingly requiring independent verification of the sustainability performance of a project, and verification throughout its life cycle that green ambitions are being realised.

Compared to green bonds (see next section), green loans are available to a broad range of borrowers and will reward the borrower with a lower cost of funding or more advantageous repayment terms. If needed, most corporates can access green loan facilities by separating out green improvement expenditure from general expenditure: for example, itemising the installation of more energy-efficient heating or cooling equipment.

Other types of greening loan facilities – or sustainability-linked loans – can be used by companies which are introducing sustainability targets or policies, such as installing energy saving lighting. And a growing trend is for credit facilities to be bound to a set of targets for reducing greenhouse gas emissions. Under these facilities – the so-called ‘positive incentive loans’ – a company’s cost of borrowing can vary depending on whether they hit pre-determined goals linked to pre-agreed targets and Key Performance Indicators.

On the personal finance front, green loans also extend to home ownership with green mortgages providing incentives for borrowers to improve the energy efficiency of a building or home, with mortgage rates discounted over a period of time based on the achievement of recognised performance standards. This can be particularly advantageous when taking on a green retrofit, whereby the costs of investing in green technology can be offset against reduced interest payments. It also means the homeowner benefits from lower running costs, making them a safer and more investable proposition for a mortgage lender.

Green Bonds

Green bonds, along with their close cousins, social and sustainability bonds, are one of the most visible market-based initiatives in green finance. Their origins can be traced back to bond issues by the European Investment Bank (EIB) in 2007 and the World Bank in 2008. The innovative 2007 Climate Awareness Bond, issued by EIB, was linked to the equity performance of a FTSE4Good Environmental European Leaders Index and raised over half a billion Euros from retail investors.

Since that time specific standards have been developed that have come to define green bonds. These have more recently been followed by sustainability and social bonds. Now becoming an established asset class with institutional investors, they have significant potential and growth with the scope and scale of green bonds issued in 2020 exceeding that of the same period in 2019, despite a temporary slowdown due to the pandemic. Green bonds are on track for setting new records in 2021.

A green, sustainability or social bond ‘ring fences’ the use of proceeds for specific activities with clear rules maintained by independent standards bodies, such as the International Capital Markets Association (ICMA), which oversees the Green, Social and Sustainability Bond Principles and the Climate Bonds Initiative. Whilst the framework and the use of proceeds information for individual bonds can be self-certified, the best practice is to have this certified by an independent third party, along with annual reporting on the impact of capital deployed.

This certification is also a requirement for inclusion in the London Stock Exchange’s Sustainable Bond Market, for example, which in 2019 launched a dedicated Sustainable Bond Market to cater for growing demand.

Green bonds are a way to tap into investors that wish to achieve green financing impact through the bonds that they invest in, allowing investors to climate and sustainable investment approaches into their portfolios. Indeed, a growing number of organisations whose business activity drives positive environmental outcomes are choosing to issue all of their bonds under a green, social or sustainability bond framework.  

Transparency and Reporting

At both international and national level, demand has grown for greater transparency and reporting around the extent to which companies and investors are exposed to climate-related financial risks and opportunities, and how they manage these risks.

In 2015, the industry-led Task Force on Climate-related Financial Disclosures (TCFD) was established to develop voluntary and consistent climate-related financial risk disclosures for use by companies providing information to investors, lenders, insurers and other stakeholders. Its rationale was that appropriate disclosures were needed for the financial community to manage and price climate risks and to take lending and investment decisions based on their view of low carbon economy transition scenarios.  

TCFD participants include three-quarters of the world’s banks and eight of the top ten global asset managers. It has developed a set of recommendations that aim to support consistent, comparable and reliable climate-related disclosures by financial and non-financial companies. Similarly, the Partnership for Carbon Accounting Financials (PCAF) is enabling financial institutions to assess and disclose greenhouse gas emissions of loans and investments, and working on harmonising the assessment and disclosure of carbon emissions that are associated with financial instruments.

So, the message is clear, green finance is providing a way forward to help the building sector decarbonise, and helping to power the transition to net zero in buildings and society as a whole. However, for buildings, like all asset classes, it is vital for net zero ambitions to be quantified in a clear and transparent way, and for progress and achievement to be monitored and verified through certification.