Sustainable finance – how focusing on ESG can help housing associations gain access to a new form of funding
Environmental, social and governance (ESG) considerations have leapt to the top of the list of investors' priorities. There is a huge drive towards green and sustainable finance, which has been spearheaded by pressure from European investors.
The introduction of the Stewardship Code which was launched in October 2019 requires pension trustees and asset managers to consider ESG factors across all asset classes when making investor decisions. Funders have realised that they should be asking their borrowers about their ESG credentials. It is a simple issue of risk management for them and there is a reputational risk in not being seen to be on top of this issue.
Sustainable finance is a natural fit for housing associations. After all, housing associations already focus on areas which can easily be badged as ESG, providing housing for the vulnerable, improving the energy efficiency of their stock, placemaking etc. However, the message from funders is that it is time for housing associations to start articulating their story better when it comes to their ESG credentials. The White Paper on standardising ESG reporting standards in the housing sector (published by The Good Economy, partnered by Trowers and others) should assist housing associations by giving them a toolkit they can use to report on their ESG metrics. Improving their ESG credentials will assist housing associations in gaining access to a completely new stream of financing from new funders to the sector who are under pressure to increase their portfolio of sustainable finance assets. These investors (such as BNP Paribas who are at the forefront of sustainable finance in Europe) are extremely keen to lend. A recent survey of fund managers carried out by US private bank Brown Brothers Harriman revealed that 74% of global investors plan to increase their allocation of ESG assets over the next year.
There are a variety of sustainable finance products available to housing associations. Green loans (which have to be in accordance with the LMA green loan principles) can be used to finance or refinance any eligible green project. The proceeds from a green loan can only be used for a green project and there has to be a clear environmental benefit to the green project such as tackling climate change, loss of biodiversity etc. The proceeds of a green loan have to be kept ring fenced in a separate account. The borrower also has to report on the green project and agree a series of performance indicators with the lender which will require third party verification.
Sustainability linked loans are a popular green finance product which some housing associations have already signed up to. The useful thing about a sustainability linked loan is that the proceeds can be used for any purpose. However, the margin under such a loan is linked to certain ESG related metrics which are set by the borrower. These metrics might relate to getting people back into work or improving the EPC rating of the housing association's stock. The borrower self certifies its own performance against these metrics, third party verification is not required. If the metrics are met then the margin under the loan reduces but if the metrics are not met then the margin under the loan will increase.
Sustainable finance can also be accessed via the capital markets by issuing green bonds or social bonds. There has been a huge increase this year in the number of social bonds issued. Under a social bond the proceeds have to be used for a "positive social outcome." The pandemic has focused peoples' attentions on their communities and social bonds have provided a stream of financing to those wishing to undertake social impact projects. The term "positive social outcome" is widely defined and includes the provision of affordable housing, employment generation, food security, socio economic advancement etc. For any kind of green or social bond third party verification of the ESG/social framework underpinning the bonds will be required from a green rating agency such as Sustainalytics which will have cost implications for the borrower.
Sustainable finance is an exciting possible stream of future financing for housing associations. It has the potential to open up a new stream of financing giving potential borrowers access to new players to the sector. Housing associations should be considering now how they can improve their ESG credentials. It is only a matter of time before funders in the sector start asking housing associations to provide details of their annual ESG reporting. As such there is simply no better time for housing associations to get ahead of the curve. Data will be key going forward as in order to establish the ESG metrics underpinning all these methods of sustainable finance, housing associations will need to know what ESG data they hold (particularly in relation to environmental matters) and what they should be capturing but currently aren't. It is clear that ESG considerations are no longer simply a "nice to have" or something that is helpful for marketing purposes but something that should be absolutely integral to the heart of every housing associations' business plan. Most importantly evidence has shown that sustainable investments have weathered the recent pandemic induced economic uncertainty far better than other investments. There is huge pent up investor need to invest in green products and green growth in the UK is four times faster than the rest of the economy. There is no better time to jump on-board.