The EU wants to become the world's first climate-neutral bloc by 2050. To achieve this goal, the European Green Deal, the "EU action plan for financing sustainable growth", sets out the necessary measures for the financial market. Real estate funding is a central component in achieving this major goal, with Pfandbrief banks having a major role to play.
Long before the Green Deal, the financial sector had acknowledged its responsibility in the fight against climate change. More than 3000 investors have signed the Principles for Responsible Investment since 2006, and 30 banks have signed the Principles for Responsible Banking since 2019. All of these players want to take an active role in managing capital flows towards sustainable growth. Furthermore, through initiatives such as Terra or Net Zero Alliance Banking, banks have committed to account for the progress made in making their balance sheets carbon-neutral.
Responsibility is essential
It is essential for players in the financial sector to take this responsibility. Whether banks, financial intermediaries or asset managers, they all have a significant influence in funding the climate transformation of the economy. Real estate finance providers have a key role to play in this: Residential and commercial real estate accounts for around 40 percent of energy consumption in Europe and around 36 percent of CO₂ emissions. In addition, 35 percent of existing properties are over 50 years old. As a result, the lending focus of real estate financiers is on projects that save energy and on renovation projects.
The Pfandbrief banks' commitment to funding more energy-efficient projects not only provided financial incentives for lending, but also created "green" refinancing instruments. In addition to unsecured green bonds, the member institutes of the Association of German Pfandbrief Banks (vdp) also developed minimum standards for issuing a "green Pfandbrief" (covered bond). At the European level, vdp is working with the European Covered Bond Council (ECBC) on the Energy-Efficient Mortgage Label (EEML) to raise the standards and transparency of green real estate loans.
In parallel with the private sector, the EU Commission has developed the EU Taxonomy Regulation as part of the EU Action Plan. It is applied both to financial market participants, such as financial intermediaries, and to companies that are subject to the disclosure requirements of the Non-Financial Reporting Directive (NFRD) in relation to the Corporate Sustainability Reporting Directive (CSRD). In addition, there are technical criteria regarding financial products or corporate bonds that are offered as sustainable.
Complex framework
The EU taxonomy is a complex framework, as it seeks to illustrate the diversity of funding scenarios in the EU and to increase transparency. The publication of the delegated act in April this year triggered a debate on the consistency, feasibility and comparability of data within the EU. One point of criticism is aimed at obtaining energy certificates for buildings constructed before 2021. Unlike in the Netherlands, for example, there is no central data register in Germany. Furthermore, the certificates are not internationally comparable. Against the background of the regional distribution of real estate funding by German Pfandbrief banks, it is apparent that on average 30 to 40 percent of funding is carried out abroad, mainly in the EU, but also outside, as in the UK, USA and Canada. As such, a precise understanding of the respective national methods and assessment measures of the energy certificates is essential. The vdp supports the ongoing harmonisation efforts.
In accordance with Article 8 of the Taxonomy, as of the 2022 reporting year, banks and investment firms are obliged to publish indicators on the sustainability of their business models, as an equivalent to companies' disclosure requirements.
A key indicator for banks is the Green Asset Ratio (GAR). It measures the proportion of taxonomy-compliant financial activities in the bank book, such as loans granted, debt securities and participations, in relation to all financial activities. The GAR applies in principle to activities in EU countries, but the institutes should classify all international activities as far as possible. The calibration of the GAR will be based either on the mandatory disclosures of the companies or on the application of the technical assessment criteria of the taxonomy.
According to the European Banking Authority (EBA), the global real estate sector accounts for 29 percent in the indicative calculations. Real estate funding makes up such a large share of the GAR because it is used in a variety of ways — through construction funding to households as well as through loans to SMEs and to companies in the construction and real estate sector and in public housing.
With regard to the technical assessment criteria for buildings, which have been difficult to compare internationally, the EBA proposes a three-year transitional period for the data collection for real estate loans and the interim application of proxies (for example, the year of construction or the top 15 percent of primary energy requirements).
GAR creates effective incentives
The EBA has not yet submitted a minimum value in its draft GAR. However, it is expected that bond investors will benchmark issuers if appropriate data quality is available, as is the case with other financial ratios such as equity and liquidity ratios and credit ratings. The GAR could therefore additionally influence the risk premium for corresponding bank securities and thus, all else remaining equal, lead to a preference for debt securities with a better GAR. In time it should provide effective incentives for banks to continue contributing to the green transformation of the economy.
As of March of this year, when the SFDR (Sustainable Finance Disclosure Regulation) came into force, investment companies must prove how their investment funds take account of sustainability criteria. Depending on the design and marketing, fund products are divided into categories such as financial products with environmental or social characteristics (Art. 8 Light Green) or financial products with a sustainability impact as their objective (Art. 9, Dark Green, for example, reducing CO₂emissions; creating affordable housing). The SFDR will be a major growth driver for the capital market with sustainable bonds and will help to increase asset managers' need for sustainable assets. Ultimately, investments in fund products under Articles 8 or 9 increase the ESG performance of the funds and the investment company itself.
This brings the cycle back to the issuers, who will issue more sustainable debt securities, if they have classified sufficient supporting assets. The process of full data collection will require a transitional period. As part of the relative valuation compared with traditional bonds, the imbalance between supply and demand of sustainable bonds should already have a positive effect on the performance of green bonds with a corresponding "greenium".
Currently, the capital market is still in a transitional phase with a need for further coordination between the institutions. During this transition phase, Pfandbrief banks should continue to communicate closely and openly with both their borrowers and their bond investors to ensure that capital is channelled into sustainable projects, so that the actual mission of the EU Action Plan is fulfilled.
Guest article by Ute Hesse, Managing Director and Co-Head of Financial Institutions and Public Sector,
03/07/2021, Börsen-Zeitung