Europe is leading in green credit, but the rest of the world is catching up
This article is the third in a four-part series on how commercial buildings are finding ways to finance sustainability projects through “green lending” and other innovative green finance techniques. The first article focuses on “green banks” and how they can help property owners get finance for clean energy projects with high upfront costs. The second part Covered green bond offerings, which take an increasing proportion of the bonds issued by the US Real Estate Investment Trust (REIT). This third part deals with green credits, the proceeds of which must be used specifically for sustainable purposes. The fourth and final part will look at green tax incentives, which some believe have been too weak, inconsistent and out of date for years, but could soon receive a significant boost from Congress and the Biden administration.
Environment, social and governance (ESG) in the financial and commercial real estate world is a hot topic right now. Still, the roots of socially responsible investing go back further than you might think. John Wesley, the English evangelist and one of the founders of Methodism, is an example of an early adopter of socially responsible investing. Many of the best-known uses of the practice have been religiously motivated. Wesley’s sermon “The Use of Money” outlined the foundations of his theory, which was not to harm your neighbor through business practices or invest in industries that harm workers, such as chemical production. “No one can win by devouring his neighbor’s substance without attaining the damnation of Hell!” Wrote Wesley. Followers of Wesley in 18ththat In the 19th century, England would avoid doing business with “sinful” companies associated with products such as weapons, liquor, tobacco or gambling. Suppose you want to go back further than Wesley’s passionate sermons. In this case, many argue that the origins of ethical investing are related to Judaism and the Jewish concept of the Zedek, what justice, justice and fairness means and the obligation to do what is right.
Fast forward to 2021, many investors and commercial property owners are showing an increasing interest in socially responsible investing, especially with regard to the effects on climate change. Even if they don’t label fossil fuel-dependent industries as “sinful”, companies still factor the costs of pollution and climate change into their financial calculations. In less than 20 years, the ESG movement has grown from a United Nations initiative to a massive global phenomenon with approximately $ 30 trillion in assets under management worldwide. Part of the global ESG puzzle that has gained momentum in recent years is green loans, a form of finance that is similar to green bonds and raises capital for environmentally friendly projects.
The International Finance Corporation of the World Bank defines green loans as an exclusive form of financing that enables borrowers and property owners to finance projects that make a significant contribution to environmental protection. In contrast to green bonds, a green loan is usually smaller and taken out in a private company. Green credits and bonds follow their uniform principles, the Green Loan Principles and the Green Bond Principles, developed by organizations such as the Loan Market Association and the International Capital Market Association. Both green loans and bonds must spend 100% of their earnings on environmental protection.
The Green Loan Principles (GLP) were issued in 2018 to promote consistency in financial markets. The GLP deals with the implementation of the proceeds from a green loan as well as guidelines for project evaluation and selection, revenue management and reporting. While the GLP is a good place to start, some real estate finance professionals feel that the principles are not robust enough. However, this has not necessarily slowed growth in the green credit market. The World Bank reports that there is currently an estimated $ 33 billion in outstanding green loans around the world, and demand is outpacing the growth of the green bond market. Green bonds come with higher transaction costs and a minimum bond size to be tradable, so according to the World Bank, issuers with smaller green portfolios usually get green loans instead of issuing a green bond.
Europe currently dominates the green lending market, but several other banks around the world, including the US, have provided green lending since 2017. Like the entire world of green finance, the green credit market is in high demand and is likely to heat up further, according to a JLL report. “A building that deteriorates in sustainability is a risk to borrowers and lenders,” said Karen Shea, managing director, Capital Markets Agency Lending, JLL. Lenders and borrowers, just like property owners, want to do the right thing, which is why the environmental compatibility of a building is increasingly being included in the loan terms. Tenants are demanding more environmentally friendly buildings, so it makes sense to secure green loans to finance energy efficiency projects. But getting LEED certification, for example, is no longer a nice thing. But that’s the cost of doing business in a world where more and more people are aware of the threats posed by climate change.
It all started with the Dutch
ING Group, a Dutch multinational banking company, made the world’s first sustainability-related loan in 2017 to Phillips, another Dutch multinational with a focus on health technology. The EUR 1 billion ($ 1.2 billion) loan tied the interest rate to Phillips’ sustainability performance. As of June 2018, ING Group had closed 15 similar deals that reduced borrowing costs by up to 10 percent based on the borrower’s ESG rating from Sustainalytics, a company that rates companies on sustainability metrics. The incentive to lower credit terms for green performance is similar to that of health insurers, which penalize smokers. The Phillips loan runs through 2022, and as the company’s ESG rating rises, the interest rate goes down (and vice versa). Since that first green loan in 2017 environment Finances compiled a list of several other banks that have partnered with ESG rating agencies to offer similar loans. Most of the loans were in European countries like Spain, Belgium and France, but in the US there were two companies (CMS Energy and Avangrid) in 2018 that received green loan finance. In Europe, ING Hines also made its first green loan available in 2021, which JLL says will provide office facilities in Frankfurt and finance an urban logistics park near London’s Heathrow Airport. Both systems have been awarded sustainability certificates and demonstrate above-average energy efficiency.
The introduction of the Green Loan Principles (GLP) was a major milestone for the market and has helped fuel a phase of sustainable growth. The principles were adopted with the help of the International Capital Market Association and closely based on the Green Bond Principles issued in 2014. The Green Loan Principles are voluntary guidelines. However, not everyone in the commercial real estate industry believes that the GLPs go far enough, and since the principles are voluntary, they do not need to be followed. Gregor Bamert, Head of Real Estate at Aviva Investors, said property week His company created its green credit rating framework because the GLPs did not do enough to address the need to refurbish older buildings. Bamert said the Green Loan Principles appear to be more about a borrower’s overall business objectives than the specific environmental impact of the loan on an asset.
The age of environmental awareness
Without binding standards, it is up to lenders and borrowers to set their own internal rules for green loans. Trowers & Hamlins, an international law firm, said: “Lenders must take responsibility for setting their internal standards or ‘eligibility criteria’ to determine what they consider to be green projects in the real estate context.” Otherwise, they risk being “greenwashed” which refers to deceptively convincing the public that the organization’s policies are environmentally friendly when it is not. Borrowers can mitigate greenwashing risk by documenting eligible projects for green credit income. The projects should always lead to a significant improvement in energy efficiency or a reduction in CO2 emissions. Green lenders are advised to be cautious at the beginning of the loan term on buildings that have been rated green but gradually fail to meet the requirements. Trowers & Hamlins suggests that lenders and borrowers agree on ways to assess the eligibility of a construction project throughout the life of the loan and incorporate those assessments into loan documentation. Finally, with most green loans, the lender requires the property owner to report the use of the proceeds annually until the loan is fully drawn.
Securing green loans offers benefits similar to green bonds. The positive media attention of getting a major green loan will help build the company’s reputation and build stronger relationships with stakeholders and investors, especially the growing interest in ESG. For property owners, a green loan that finances significant projects in the field of energy-efficient or renewable energies also helps to attract employees and tenants who value sustainable commitment. Although green loan lenders may have different standards, you likely need to meet something similar to the four core components of the Green Loan Principles to qualify. This includes how the loan proceeds are credited to a dedicated account and quantitative performance indicators such as energy savings are reported to show the impact of the loan. The green projects that a property selects must provide clear assessments, measurements and reports on the environmental benefits.
European capital has been at the heart of the green credit market, but America and other international markets are gaining momentum. With climate change making the headlines most days, there is growing recognition that real estate investments need to step up their game to become more energy efficient and reduce carbon emissions. Green loans are several sustainable financial tools that can help property owners with this. While the Green Loan Principles can have some shortcomings, they still serve as a good framework for assessing whether you will qualify for a green loan and how you will manage and report earnings over time. If you meet the sustainability metrics, lenders are likely to offer cheaper green loans that help property owners comply with increasing environmental regulations, save money on energy bills, while building an environmentally friendly reputation. That kind of socially responsible investing that helps the planet would likely make religious ancestors like John Wesley proud. Contributing to climate change may not be a “sin”, but it certainly won’t help your commercial real estate business today at a time when environmental awareness is more important than ever.