Green finance is one of the hottest topics on the ESG agenda at the moment. Having taken off in the past year as investors increasingly look to build greener portfolios and lenders increasingly focus their lending strategies on sustainability principles, the use of green finance is only set to grow further as we race towards net zero.
But what are the challenges and rewards? Property Week editor Liz Hamson sat down with Omega Poole, a partner and head of debt advisory at Mishcon de Reya, to find out.
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Liz Hamson: What are the benefits of green and sustainability-linked loans and what is the difference between the two?
Omega Poole: Terminology has changed over the last few years but in simple terms, green loans are those where the loan proceeds are used within a green project and the project is assessed and measured in that way. With sustainability-linked loans, on the other hand, the proceeds from the loan can be used for general corporate purposes, but the loan mechanics incentivise the borrower in some way based on ESG KPIs.
So what are the benefits of green and sustainability-linked loans? We are all of the mind that they play an increasingly important part in supporting the real estate market to improve the sustainability characteristics of our property stock. But there are also benefits for lenders themselves. Investors in those lenders are increasingly focused on ESG criteria, so there is a spotlight put on lenders by their own stakeholders.
One point to flag up is that although it is obviously important to have these loans in the context of new buildings, arguably even more importantly is to be using these types of loans to transition existing stock in its current state to a more sustainable product.
LH: How easy is it to get these loans for existing stock?
OP: A number of lenders have actually had products specifically designed to support the transition of stock from existing stock to new stock. Aviva is a good example, with its commitment of £1bn of loans in the next four years for exactly those kinds of assets.
LH: Has it been a battle to convince people of the merits of applying these loans to existing stock?
OP: In all of the conversations we have with lenders, they are very focused on ESG generally, but they’re obviously also at different stages. Some lenders are at the stage where they are encouraging or requiring their borrowers to complete very detailed due diligence questionnaires around ESG requirements, but they might not have specific KPIs in their loan documentation.
LH: What are some of the practical challenges?
OP: The main practical challenge is really setting meaningful KPIs. The LMA [Loan Market Association] has set some really useful guidance for borrowers and lenders about what these metrics should look like, and they make it very clear that they should be ambitious and meaningful.
They also suggested considering using a sustainability co-ordinator. It could be the case that lenders and borrowers themselves do not have the right in-house expertise to identify the right metrics, so they can work with an external third-party consultant or certifier that can help them set these types of metrics.
Another challenge we talk about a lot is the standardisation of data that is collected at a property or asset management level, and that can itself present challenges. But some lenders have solved this problem of setting KPIs by developing their own robust, rigorous frameworks and they might bundle KPIs into those considered higher priority and those considered as medium priority.
LH: There is a lot of focus at the moment on the ‘E’. What about the ‘S’ and the ‘G’? Those are potentially more challenging aren’t they?
OP: They are, and when we speak to lenders, they make exactly that point. It can be harder for them to measure the ‘S’ and the ‘G’, although it is not necessarily impossible. One of the key areas that a number of lenders are looking at is wellness, and there are various certifications to measure wellness associated with property use and occupation.
We’ve seen a number of lenders really step up to the plate with bold commitments
But even though it can be harder to measure these KPIs, lenders are still very focused on how they can incorporate them into their green and sustainability-linked loans.
LH: What is the danger of greenwashing and how many of these loans are not really what they have cracked up to be?
OP: We really need a sense of balance here. As an industry, we want to be encouraging lenders as they move through that thought process and try to incorporate more and more ESG criteria and encourage their borrowers to do the right thing. On the other hand, it can’t just be a case of business as usual. Really, I think, the acid test is looking at these new requirements, the new capex required, and seeing whether it is over and above what would be business as usual. If so, then there is a meaningful change being made.
LH: What need to be the next steps from government and industry to see green loans really take off?
OP: We’re expecting there to be much more by way of disclosure. We see there is regulation in the pipeline, and that means there will be a lot more transparency in the market. That is perhaps a stick for the stick-and-carrot equation.
But consider whether the government should provide more of a carrot, perhaps in the form of incentives to lenders who are willing to write these loans where there might be a margin ratchet to reward good behaviour by their borrowers.
On an industry level, we’ve seen a number of lenders really step up to the plate either with bold commitments or by sharing best practice. For example, Aviva has taken the step to publish its sustainable transition loan framework so that everybody can see exactly how it is going about writing these loans.
LH: What about the smaller players – where do they start?
OP: That is where the use of external consultants can be helpful and working with their lenders, too. Lenders are getting more and more sophisticated about how they underwrite these types of loans, so if borrowers raise the question with their lenders, their lenders might either have in-house capability around how to create the right metrics for ESG, or will already be working with third-party certifiers. The borrower doesn’t need to do all the heavy lifting on this themselves.
LH: How prevalent will green finance be in five years’ time?
OP: I suppose my hope is that more and more lenders will move toward incorporating ESG as a day-to-day part of their underwriting. If you ask a lender now if they will finance a building just because it has fantastic ESG credentials, the answer is obviously no, because they need to make appropriate risk-adjusted returns for their own investors.
Yet more and more, if you ask them whether they will finance a building that has fantastic potential returns for your loan but fails on major ESG criteria, lenders will increasingly say that they do not have appetite for that.