Construction Financing for Green Projects

It’s reasonable to argue that without green finance, we won’t be able to attain net zero in the built environment. Green finance is currently playing a crucial role in the race to net zero for constructions. Lenders and investors understand that green construction reduce risk and improve long-term value in addition to their desire to be socially conscious. Future homeowners will find green buildings easier to sell because they are built to withstand the negative effects of climate change. Additionally, financiers are well aware that buildings that do not prioritize sustainability risk becoming “stranded” assets in the future. Construction projects that don’t function well may eventually become unusable or unlettable as regulations tighten.

Due to this, the majority of lenders and investors now have robust ESG agendas, specialized sustainability teams to assist in addressing climate challenges, and innovative financing models that prioritize environmental concerns.

The phrase “green finance” is now widely used to describe a loan or bond that is specifically designed to be environmentally friendly, but what exactly does this mean?

We examined the common difficulties investors encounter when attempting to lend money into the green building market in our earlier blog. We will explore the true nature of green finance and its application to buildings today.

To put it simply, green finance involves either using the proceeds to fund environmentally friendly projects or using green assets to generate income. Usually, there are two primary formats available: green bonds and green loans.

Green Credit

Any kind of loan instrument made available to fund new or ongoing green projects is referred to as a green loan. Clear environmental benefits should result from these projects, which the borrower must first quantify, evaluate, measure, and report on. Lenders are progressively demanding independent confirmation of a project’s sustainability performance as well as confirmation that its environmental goals are being met at every stage of development.

Green loans are more accessible to a wider range of borrowers and offer more favorable repayment terms or lower funding costs as compared to green bonds (see the section below). The majority of corporations can obtain green loan facilities if necessary by isolating the cost of green improvements from other expenses, such as itemizing the installation of more energy-efficient heating or cooling equipment.

Companies adopting sustainability goals or policies, like installing energy-efficient lighting, can make use of other kinds of greening loan facilities, also known as sustainability-linked loans. Furthermore, it’s becoming more common for credit facilities to be subject to a set of goals for cutting greenhouse gas emissions. A company’s cost of borrowing under these facilities, also known as “positive incentive loans,” varies based on whether or not pre-established goals connected to pre-agreed targets and Key Performance Indicators are met.

In terms of personal finance, green loans also cover home ownership. Green mortgages offer incentives to borrowers to increase a building’s or home’s energy efficiency by reducing mortgage rates over time in response to the fulfillment of established performance standards. This can be especially helpful if you’re doing a green retrofit, as the costs of buying green technology can be written off against lower interest rates. Additionally, the homeowner will experience lower operating expenses, which will make them a safer and more appealing investment for a mortgage lender.

Green Notes

Green bonds are among the most well-known market-based initiatives in green finance, along with their closely related cousins, social and sustainability bonds. Their inception can be linked to bond offerings by the World Bank in 2008 and the European Investment Bank (EIB) in 2007. With the help of retail investors, the EIB’s creative 2007 Climate Awareness Bond raised over half a billion euros and was correlated with the equity performance of a FTSE4Good Environmental European Leaders Index.

Since then, particular guidelines have been created that have come to characterize green bonds. More recently, social bonds and sustainability have taken their place. Despite a brief slowdown brought on by the pandemic, green bonds are now an established asset class with institutional investors and have significant growth potential. In 2020, the scope and scale of bonds issued exceeded those of the same period in 2019. In 2021, green bonds are expected to reach all-time highs.

A green, sustainability, or social bond “ring fences” the use of proceeds for specified purposes under well defined guidelines upheld by impartial standards organizations like the International Capital Markets Association (ICMA), which is in charge of the Climate Bonds Initiative and the Green, Social, and Sustainability Bond Principles. While individual bonds’ frameworks and uses of proceeds information can be self-certified, it is recommended to have these certified by an impartial third party in addition to submitting an annual report on the impact of capital deployed.

For instance, in order to participate in the London Stock Exchange’s Sustainable Bond Market, which it established in 2019 in response to increasing demand, this certification is also necessary.

By enabling investors to incorporate climate and sustainable investment strategies into their portfolios, green bonds are a means of reaching out to investors who hope to achieve a green financing impact through the bonds they invest in. In fact, an increasing number of companies whose operations result in favorable environmental outcomes are opting to issue all of their bonds within the framework of green, social, or sustainability bonds.

Openness and Reporting

The need for more openness and reporting about how much exposure businesses and investors have to climate-related financial risks and opportunities, as well as how they manage those risks, has grown on both a national and international scale.

To create voluntary and uniform climate-related financial risk disclosures that businesses can use to inform investors, lenders, insurers, and other stakeholders, the industry-led Task Force on Climate-related Financial Disclosures (TCFD) was founded in 2015. The reasoning behind it was that in order for the financial community to manage and price climate risks and make lending and investment decisions based on their assessment of transition scenarios toward a low-carbon economy, appropriate disclosures were required.

Eight of the ten largest asset managers worldwide and seventy-five percent of the world’s banks are members of TCFD. It has created a set of guidelines to help financial and non-financial companies disclose information about climate change in a consistent, comparable, and trustworthy manner. Comparably, financial institutions can now evaluate and report the greenhouse gas emissions of loans and investments thanks to the Partnership for Carbon Accounting Financials (PCAF), which is also aiming to standardize the reporting and assessment of carbon emissions related to financial instruments.

Thus, the takeaway is crystal clear: green finance is offering a path forward to support the building industry’s decarbonization and the shift to net zero in both buildings and society at large. Like all asset classes, however, buildings must have their net zero goals quantified in a transparent and understandable manner, and their accomplishments must be tracked and validated by certification.