In the European Union buildings are responsible for approx. 40% of energy consumption and approx. 36% of CO² emissions which is why the real estate sector is certainly one of the key markets for green and sustainable finance. Against this background the loan market industry is increasingly focusing on the development of principles and frameworks which provide the lender and the borrower side more reliability and predictability in relation to green and sustainable investments. In this context the Loan Market Association (LMA) has published new guidance in rela-tion to the application of Green Loan Principles (GLP) to the Real Estate Sector financing in November 2020.

According to the European Commission buildings are responsible for approximately 40% of energy consumption and 36% of CO² emissions in the European Union; in addition, about 35% of the Union’s buildings are over 50 years old and almost 75% of the building stock is energy inefficient. The Commission estimates that renovation of existing buildings has the potential to lead to significant energy savings, potentially reducing the EU’s total energy consumption by 5 to 6% and lowering the EU’s CO² emissions by about 5% (https://ec.europa.eu/info/news/new-rules-greener-and-smarter-buildings-will-increase-quality-life-all-europeans-2019-apr-15_en).  Beside the European Union’s efforts to regulate the energy performance of buildings by its Directive (EU) 2018/844 [Directive (EU) 2018/844 of the European Parliament and of the Council of 30 May 2018 amending Directive 2010/31/EU on the energy performance of buildings and Directive 2012/27/EU on energy efficiency] , the loan market industry is increasingly focusing on the development of principles and frameworks which provide both lender and borrower with further guidance on green (and sustainable) financing.

The LMA’s has recently published two guidelines for the real estate finance industry, (a) the Guidance on the application of the Green Loan Principles in the real estate finance (REF) investment lending context – Green buildings (the Green Building Finance Guideline) and (b) the Guidance on the application of the Green Loan Principles in the real estate finance (REF) lending context – Retrofit projects (the Retrofit Projects Finance Guideline).

The core components underlying the guidelines are in line with the Green Loan Principles (GLC) developed by the LMA, the Asia Pacific Loan Market Association (APMLA) and the Loan Syndications and Trading Association (LSTA) as follows:

• use of proceeds
• process for project evaluation and selection
• management of proceeds
• reporting

Green Building Finance

The Green Building Finance Guideline provides the following examples where “green finance” may be applied:

• acquisition or refinancing of green buildings or portfolios
• financing capital expenditure on buildings that makes a positive contribution to environmental goals
• retrofit projects

Against the background that no universally applicable definition on what constitutes a “green” building has been developed yet, the Green Building Finance Guideline recommends that lenders and borrowers shall agree a process of determining eligibility of the relevant building at predetermined dates during the term of the loan.

One further achievement of the guidance is that there is a recommendation of the LMA which certifications and standards may serve for determination of the green factor of a specific real estate, classified into company/fund level certifications (such as the alignment with the EU Taxonomy [Regulation (EU) 2020/852 of the European Parliament and of the Council of 18 June 2020 on the establishment of a framework to facilitate sustainable investment, and amending Regulation (EU) 2019/2088.]), design based certifications, certifications for refurbishment & fit-out and in-use certifications and disclosures covering the live-span of a real estate financing. 

Retrofit Projects Finance

The LMA’s Retrofit Projects Finance Guideline recognizes the opportunities and core factors which arise in the context of retrofit projects in the real estate market, in particular the financing of retrofit activities as a viable alternative to demolition and replacement of buildings which mostly constitutes a less sustainability friendly approach considering its carbon footprint.

Highlighting that eligible retrofit projects shall “result in a material improvement in the energy efficiency of, and result in a material reduction in the carbon emissions associated with the building”, the Retrofit Projects Finance Guideline stipulates the following non-exhaustive categories which may serve as a starting point for lenders and borrowers in developing green criteria:

• Basic efficiency measures (e.g. draught-proofing, envelope insulation)
• Enhanced efficiency measures (e.g. double-glazing, wall insulation, energy efficient doors)
• Heating measures (e.g. air/ground heat source pumps, pump replacement)
• Energy generation (e.g. solar/wind generation, district heating services)
• Resilience measures (e.g. flood/heat wave resistance products)

According to the LMA certifications and standards which are mentioned in the Green Building Finance Guideline may also apply in respect to retrofit projects. In addition, the LMA points to specific standards and certifications developed for retrofit projects, such as the BREEM Refurbishment and Fit-Out rating, RICS SKA, PAS 2035, Passivhaus and EnerPHit Standards and TrustMark.

Outlook

While financial institutions and professional borrowers currently tend to assess green-eligibility of real estate projects on a case-by-case basis or have developed their own general green finance framework and eligibility criteria, the LMA’s guidelines on green buildings and retrofit projects are another piece of the puzzle in the green finance market establish-ing general standards which help to build trust in and therefore broaden the market (and sources) for green investments. The application of generally accepted standards will also be a decisive competitive advantage when it comes to the refinancing of green real estate finance projects.