At present, the ESG investment sector is held back by a lack of accurate qualifying data and, partly because of that, a lack of clear definitions of what counts as ‘green’. This creates barriers to those seeking to tap into investor demand with green investment products, whilst those who define their own products as green are left open to accusations of greenwashing.
With the push to Net Zero now firmly underway, it is imperative that the industry rally around clear definitions, supported by clean and transparent data.
At Kamma we’ve identified some clear opportunities for banks, lenders and investors to go green, without attracting accusations of greenwashing.
Issue bonds under existing guidance
The first opportunity is to deliver green bonds using international third party definitions. In March 2021, the EU set out new regulations for the finance industry in an attempt to reduce greenwashing in the sector. Fund managers are now legally required to disclose how bonds are sustainable. Following the announcement, the UK government announced the launch of the Green Technical Advisory Group (GTAG) – an independent body of experts that will inspect the ‘Green Taxonomy’, which refers to the framework that defines environmentally sustainable investment in the UK.
Yet, with other third parties issuing green ratings, there is no reason for UK firms to wait for this new framework to be enforced. In 2019, for example, Insight Investment assessed over 70 green bonds. They outlined that 15% failed to meet the minimum criteria, proving that this is more than just a tick box exercise and arguably increasing the value of their ratings for the 85% that passed. By the end of 2020, the yearly global green bond and loans market reached almost $195bn, with 24% of that issuance certified under the international Climate Bond Standard. With almost a quarter of green bonds using third party guidance to qualify, there is no reason for UK banks to hold back.
Mortgage backed bonds and securities can be qualified as green by using EPC data, which provides insight into the underlying assets’ energy efficiency. The EPC registers provide a solid indication of energy performance of UK housing stock. However, the methodology (known as SAP) is used to measure energy efficiency and was developed back in 2012. Whilst a more efficient home will have a smaller energy footprint than an inefficient one, it is not always an accurate measure of emissions. Efficient homes that burn fossil fuels for example, will be more polluting than an inefficient home with solar power and a heat pump.
It’s for this reason that EPC assessments also include an Environmental Impact Rating (EIR) which is linked specifically to emissions data. The Climate bond standard recommends using EIR as a metric for qualifying houses as green. In doing so, bond issuers can not only avoid greenwashing, but the total UK housing stock available for green investment increases from 12.43% to 15.26%.
That’s not to say that EER-driven EPC ratings are unimportant, they are currently the basis of a lot of government policy and are therefore an important determinant of transition risk. Without an industry-wide transition to an EIR-focussed approach, both data points need to be used to deliver transparency, even if EIR is the stronger measure of carbon footprint.
Figure 1 and 2 illustrates the difference between EPC (EER) and EIR data in the UK
Even if these improvements are made, we are still yet to deal with the main criticism that issuer companies face: that green underlying assets can be securitised as green, with the proceeds then invested in environmentally unfriendly projects, or vice versa. To sidestep this, banks can consider double qualifying their investments, ensuring both the underlying assets and the use of proceeds can be defined as ‘green’ and accurately and transparently so.
This is important when considering the sheer scale of the challenge in upgrading UK housing stock. Whilst the government has proposed that mortgage lenders take responsibility for increasing the average EPC performance (based on their properties EER score) of their own portfolio to Band C, by 2030, Kamma estimates that this could cost an estimated £48.3 billion. By double qualifying green securitisations, lenders can both benefit from green investor demand and fund the improvements that the UK housing stock desperately needs.
This may sound like a challenge but is the approach taken by the Dutch bank Obvion who in 2016 issued the world’s first 100% green securitisation.
The key to establishing more transparency and accountability in the finance industry is to utilise reliable and accurate data to qualify against third party guidance. With both the data and these definitions now available lenders can sidestep the third accusation of greenwashing through double qualification. In doing so they can kickstart the green lending revolution that UK housing stock desperately needs, defeating accusations of greenwashing once and for all.
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