Sustainable Finance Products: Deep Freeze or Thaw?

So-called "labelled" sustainable finance products have become less popular across the market in the last few years, even though sustainability remains central to the political and real estate market agenda, as well as lenders' strategic thinking. 

What are "labelled" sustainable loans

• Sustainability-linked loans (SLLs): typically revolving credit facilities, where there is an decrease in margin for satisfying sustainability performance targets, subject to external verification.
• Green loans: typically term loans which are lent to finance an asset or development that satisfies or will satisfy sustainability criteria (a "use-of-proceeds" product).

Why are "labelled" sustainable loans less popular than anticipated?

• Challenging macroeconomic environment: since 2019, overall volumes of lending have been lower than in previous years.  Focus has often been on managing existing positions through economic uncertainties and the increased cost of debt, rather than having the motivation or high volume of opportunities to use sustainable finance products.
• Greenwashing: all parties are concerned about reputational risk in badging a product green or sustainable unless it is sufficiently robust.  Lenders' concerns around greenwashing have led to a focus on the inclusion of fulsome contractual terms; these may be onerous and sponsors may be concerned about potential breach.
• "Labelled" products are not the only path to green credentials for sponsors:  sponsors may well take the view that whilst green debt products advance the green credentials of lenders, sponsors do not need those "labelled" debt products to own and develop sustainable real estate; the same can be achieved using "unbranded" debt.
• Cost/benefit analysis: the margin reduction for satisfaction of a sustainability target in an SLL has not kept pace with interest rate increases, and the market does not universally agree that there is a "greenium", a pricing benefit for a green loan.  This means that the cost of negotiating the additional contractual terms, and of compliance with additional reporting and any verification requirements are not always outweighed by the financial incentives on offer.

What have the loan trade bodies done to help the market?

Various loan market trade bodies developed guidelines for the loan market on how a green loan could be used in a real estate finance context for either funding a green building or a retrofit project.  These were detailed and helpful, setting out some examples of what might constitute an eligible green real estate project. 

The Loan Market Association has sought to further assist the market by producing some draft wording to be used as a starting point in both sustainability-linked and green loans, to attempt to streamline the documentation process.

Might things change in 2025?

Since sustainability-linked loans include ambitious and stretching sustainability performance targets, satisfaction of which is measured and has consequences, they are arguably a transition product.    

What is transition finance?

It is a wide-ranging term which can encompass financing hard-to-abate and high-emitting sectors as well as financing the economy-wide transition to net zero.

Transition finance has been in sharp focus in the last 12 months.  The UK Transition Finance Market Review (TFMR) has made a number of recommendations on how to scale and develop the transition finance market, which is a key step in achieving net zero.

• Labelled sustainable finance instruments may still be important.  The adoption of transition plans by corporates (and the associated on-going improvement to disclosures) should make it easier to set sustainability targets and monitor compliance with them. 
• Transition loans as a separate category: Specific principles and guidance for transition loans are being considered, too.  A specific use-of-proceeds transition finance product has also been suggested, to make funds available for assets or developments which are vital in the energy transition but which could be considered more olive or khaki than pure green. 
• Blended public/private finance initiatives: Novel ways in which finance could be used to catalyse decarbonisation in the real estate sector are also being discussed, including using blended finance, a public/private finance mixture. 
• Different sectors have different needs: the report recognises that the real estate sector needs widespread adoption of incremental changes such as improving energy efficiency in buildings. 

To date, the ability of a sponsor to own or develop sustainable real estate assets has not been dependent on using "labelled" sustainable finance products.  The question is whether take up by sponsors will increase because the pricing advantage becomes more meaningful or the "labelled" products become the most readily available form of funding sustainable real estate assets.  However, the sustainable finance market is a dynamic and reactive one, and capital providers are consistently coming up with new ways to finance the drive to net zero.

Come back tomorrow to open the door to Day 12 of our advent calendar for an update on the Renters' Rights Bill .