Why write a sustainable finance framework?
Over the last two years, the social housing sector has embraced sustainable finance. Almost all new social housing issuance since November 2020 has had some form of ESG labelling, and sustainable bond issuance in the sector stands at £7.2bn. Uptake has been driven by high investor demand and the allure of better pricing. While this ‘greenium’ remains difficult to pin down, many issuers have claimed that their sustainable finance label gave them access to a wider pool of investors and enabled them to achieve tighter pricing.
While regulation and policy relating to sustainable finance remain limited, a clear market convention has emerged whereby issuers must first publish a sustainable finance framework. This permits the inclusion of subsequently issued bonds in sustainable indices and funds, and signals to investors the sustainable credentials of the bond or bond issuer.
How to go about writing a framework?
A framework should reflect the business’ purpose and strategy. What it is that the business does, and what it is trying to achieve in the near future, should be immediately clear from the framework’s rationale. The use of sustainable financing frameworks should be geared around the need to mitigating key ESG risks and maximise ESG impacts.
There are three types of sustainable bonds: use of proceeds, transition, or issuer-level classified bonds.
Use Of Proceeds is the more commonly used structure, wherein the funds raised are allocated to one or more social, green or sustainability (social+green) projects. These are set out by the International Capital Markets Association (ICMA) sustainable finance principles and guidelines.
Transition bonds relate the sustainable bonds issued with the purpose of funding an organisation’s climate/just transition strategy.
Issuer-level classified bonds are issued by organisations whose core business is inherently green or sustainable.
The structure chosen should reflect the issuer’s corporate purpose, business model and strategy. Issuers should consider the balance between specific and organisational outcomes and objectives, and how to demonstrate a clear trajectory to investors.
MTVH issued a sustainable bond in July 2021 to raise £250mn. James Shallis, Head of Sustainability, says of the process: “As a provider of social housing, we have a caring ethos by nature with historically strong social and governance credentials. We wanted to ensure that we also placed importance on the environmental credentials also. Our Sustainable Finance Framework was created to complement our Sustainability strategy (Our Sustainable Future) and 2030 Action Plan, our Ritterwald Sustainable Housing Accreditation and our ESG reports, linked to the Social Housing reporting Standards.”
Best practice continues to be to write a framework aligned with the ICMA sustainable finance principles and guidance. This stipulates at the very least four key areas:
- Use of Proceeds
- Process for Evaluation and Selection
- Management of Proceeds
The first section sets out the type of bonds and the eligible ‘projects’ that can be invested by bonds issued through the framework. Issuers should take care to detail the rationale for their framework, as well as how it contributes to and aligns with the UN’s Sustainable Development Goals. It should be very clear what the eligibility thresholds and standards are, and how they will be measured.
In THFC’s group framework, for example, housing associations were stated to be ‘pure players’ in terms of their social impact, and were treated as the underlying ‘project’. This permits corporate financing on the grounds that THFC only lends to non-profit, Registered Providers of social housing. For the green projects, associations are required to allocate a portion of funds to specific ICMA aligned green projects such as Green Buildings and Energy Efficiency.
The process for evaluation and selection details how projects are chosen and allocated. Take care to indicate which committees or boards will have responsibility for this process. If there will be an interval between the issuance of the bonds and the allocation of proceeds to a sustainable ‘project’, the framework should stipulate how the proceeds will be held or invested. Even for housing associations or social housing aggregators, where the HA themselves are the project and therefore there is no such interval, it is best practice to indicate how proceeds will be managed.
SRS and KPIs
The metrics used as Key Performance Indicators (KPIs) in a sustainable financing framework are of great importance. Not only should they be relevant to the rationale, but also material to the business. They should demonstrate ambition in achieving impacts aligned with the SDGs and be stretching.
KPIs are not just used to demonstrate the impact of the projects funded through the framework, but also to drive change within the issuing business. Executives may use them to signal to their own employees what their strategic vision is, and to ensure Board buy-in on ESG goals. At present there are no punishments for failing to meet KPIs other than reputational damage. In sustainability-linked bonds the fulfilment of KPIs is linked to a step-up/down in the coupon; but failure to meet KPIs is not covenanted as a default.
In the social housing sector, it has become convention to link KPI metrics to the criteria found in the sector’s Sustainability Reporting Standard. This link ensures that sustainable financing products are consistent in their data use with broader ESG disclosure formats.
Anup Dholakia, Director of Corporate Finance at Network Homes, which recently published its Sustainable Finance Framework, emphasised the role of the framework in helping focus the business on sustainability objectives: “There is growing regulation and scrutiny from stakeholders (residents, funders and other interested parties) on how investments in Network Homes will be used and how this reconciles with the objectives set out in our sustainability strategy.
“This framework will help us clearly demonstrate this, highlight where there is room for improvement and sharpen our own corporate governance in this area. We were keen to recognise from the outset that ‘perfect’ ought not be the enemy of ‘good’ in our first framework, and that it would be a continual learning process to improve the framework over time.”
A framework should be subject to a Second Party Opinion, which provides external verification that the framework is aligned with the relevant ICMA principles and its contribution to sustainable impacts and risk mitigation. The SPO gives investors and other stakeholders comfort as to the veracity of claims made about the sustainability of the projects being financed.
Annual reporting should be completed detailing the progress made toward KPIs or allocated projects. This will include impact metrics too e.g. an HA might detail the capital expenditure allocated to green buildings, as well as how many buildings were completed in the year and their energy efficiency. A retrofit based project might include both the number of units retrofitted and the estimated carbon savings as a result.
If the projects or KPIs selected are at an organisational level, this may require organisational level disclosure rather than project level.
Within a short space of time sustainable finance has become the dominant type of borrowing among housing associations. Appetite for sustainable investment opportunities is large, as is the pressure to disclose, and these trends show no signs of abating. The number of sustainable financing frameworks published by associations is likely to grow even more, as the sector finds a place for itself in the new sustainable investment market.