Demystifying sustainable finance
The global financial sector has for the last few years been shifting its position and priorities in order to align itself with the wider public concern over the climate crisis and social equality. The importance of harnessing finance to tackle climate change was demonstrated during the COP26 conference in Glasgow where day two of the event was dedicated to this topic.
Every sector and industry will have experienced some kind of trickle down effect of this new way of thinking and this is certainly true in the UK social housing sector.
Where housing associations previously raised private finance there has been a flood of deals which are linked to sustainability. In fact, according to NatWest, in 2021-22 88% of all HA issuances were linked to sustainable projects in one form or another. Looking at 2022 in isolation, that figure rises to 100%.
So what are the options for HAs looking to raise sustainable finance? And will all transactions be ‘sustainable’ in future?
The options
To date, the majority of HA issuance has been sustainability-linked loans and sustainability bonds (aggregated or otherwise).
The majority of HA issuances to date have been so-called “use of proceeds” bonds which require the money raised to be spent on sustainable projects. Less common are Sustainability-Linked Bonds (SLBs) which are structurally linked to KPIs relating to sustainability. For instance, failure to meet agreed targets can result in an increased coupon rate for the borrower.
Loans are typically bespoke in terms of individual KPIs and target structure, says George Flynn, Vice President of NatWest Markets.
He adds: “In the early days these were mostly linked to environmental targets, especially around improvements to EPC ratings, but increasingly we are seeing social and governance aspects being used, such as board diversity.”
There is typically a margin benefit for associations meeting their agreed targets, compared to traditional loans in the region of a few basis points. Whilst seen by some as a fairly insignificant saving, it does show there is currently some incentive for HAs to seek this type of loan and it could be argued that there is value over the term of a long-dated bond.
HAs also have the option of seeking a private placement, the vast majority of which are structured under Loan Market Association (LMA) principles. Private placements have predominantly been used by smaller HAs as a way of accessing sustainable debt, some of which have been sustainability KPI-linked issuances.
More recently, L&Q became the first HA to issue a sustainability-linked bond. This £300m bond includes a set of requirements relating to emissions reductions, EPC ratings and the amount of new homes it builds that are affordable.
Martin Watts, Director of Treasury at L&Q, says: “We are of the opinion that the issuance of sustainable products has led to improved pricing and will continue to do so, and therefore should become the norm for the sector. This has been evidenced by transactions issued by the sector during 2021 and for L&Q’s deal, a new issue premium of 2bps compared to an average new issue premium of 9bps in the UK/Euro market at the time of issuance. This 7bps saving is equal to a net present value saving of £1.9m.”
Despite this, George Flynn says he does not expect a “swell of clients coming to do SLBs”. This is because L&Q, being a major HA, was able to issue the bond with a 10 year maturity date and targets set for 2024/25. For smaller clients looking to 30-year transactions, these short-term targets would not make sense.
Similarly Samuel Marlow Stevens, ESG and Treasury Associate at THFC, says despite being well-received by the market there is little sign that this type of product will be replicated widely due to the “lack of relative benefits compared to a standard sustainability bond structure.”
Sustainable finance frameworks
For many HAs, the first point on their sustainable finance checklist will be to set up a sustainable finance framework. A number of large HAs have done this already including L&Q, Platform, Peabody, Bromford and Wheatley to name a few.
Rosemary Farrar, Chief Financial Officer at Platform Housing Group, says the group had a “blueprint” for the framework after launching their debut (non-sustainable) bond in July 2020.
She says: “It is very important to us to make it sustainable because Platform is moving ahead to meet the 2050 net zero target comfortably and we have already built in the cost of carbon neutral to our long term financial plan.”
Rosemary Farrar expects to see more HAs setting up a sustainable finance framework.
She says: “For those that are not going out for sustainable money, there is going to be less and less choice. It is going to become something that becomes a necessity in our sector.
“If an investor is looking at two HAs with similar financial metrics but one has better sustainable metrics, they are going to go with the one with sustainable metrics.”
Making targets ambitious
Sustainable finance within the UK social housing sector is still at an embryonic stage, with the first loans and bonds being issued in the last three years. This means that any targets associated with the various issuances are relevant to today’s market, but may well need to be renewed over time.
As Samuel Marlow-Stevens explains, a fundamental question around sustainable financing is the balance between ambition and realism.
He says: “A distinction can be made between products that are green, greener or greening; in other words do they focus on attaining a certain standard, on a relative performance when compared to peers or a benchmark, or simply on proof of a certain direction and speed of travel?”
Without clearly communicating the exact aims of your sustainable product HAs can fall into the trap of greenwashing – overselling your Environmental, Social and Governance (ESG) credentials.
HAs must be aware targets set in 2020 will not be enough when raising sustainable finance in 2025. For instance, EPC ‘B’ is currently the standard for new builds and is seen as a good standard of energy efficiency that is attainable. But it is conceivable that EPC ‘B’ will not be regarded as sufficient for sustainable funding in the future, especially when considering that 2025 will see the introduction of the Future Homes and Future Buildings Standard.
On the other hand, George Flynn expects to see the banks becoming more sophisticated in their asks from borrowers.
He says: “Public bond investors are increasingly coming under more scrutiny in terms of their investments and they are asking a lot more tailored questions of housing associations on topics such as scope 1 and scope 2 emissions, costing for net zero and the key challenges in terms of reaching net zero.
“These are quite challenging questions for the associations but they really drill into what the underlying future holds and what challenges will be put on the business and how this is being prioritised.”
He also suggests that investors want to see additionality, and that allocating a portion of a bond or loan to capital expenditure may be an important aspect of future transactions.
Room for improvement
One of the key ways HAs can have an impact on the climate crisis is by retrofitting existing housing stock so that it is more energy efficient.
Indeed, much of HAs’ “use of proceeds” cash is funneled into retrofit projects as well as building new green homes, rent receipts from which can service interest costs. However, as Samuel Marlow-Stevens notes, there is a persistent lack of suitable debt products available for retrofit.
He says: “The problem is that retrofit ideally needs long tenors for small amounts, and so is perfectly suited to aggregated funding but less so to bank loans or own name bonds. However, efforts to correct this continue to gather pace, particularly with the disbursement of the first wave of Social Housing Decarbonisation Fund grant.”
THFC’s recent research paper ‘Retrofitting Social Housing: A Funding Roadmap’ identifies sustainable bonds as a key part of the solution to the retrofit challenge but this should be supplemented by guaranteed debt funding and continued grant funding from central government.
Rosemary Farrar believes improvements are also needed on the borrower side. In particular, she is keen to see housing associations improving their communications with investors.
She says: “It is all about investor communication. A lot of the sector does good work but does not showcase it very well.
“I think investors will be looking for HAs demonstrating better evidence [of how funding is used] going forward.”
She recalls how Platform spoke to an independent advisor when it launched its first ever bond and suggests the lessons around investor communication were invaluable.
The emergence of the Sustainability Reporting Standard for Social Housing will be a useful tool in the push to improve investor communication and understanding in the sector. The standard, of which THFC is an early adopter, will help HAs demonstrate to investors how their investment will be used and why the sector is a viable ESG investment.
Housing associations are in many ways spoilt for choice when it comes to funding instruments, with plenty of banks, investors and aggregators through which to secure investment. What will be important going forward is that borrowers choose the right instrument that aligns with their organisation’s specific goals. On top of this, these goals will need to be adapted over time to ensure they remain ambitious and are ultimately improving the sector’s sustainability.
