How to avoid the Wild West stage of ESG

Insight & comment05.05.227:00 AM by Keith Cooper

Investors are interested in environmental, social and governance-linked bonds. But it is a bit of a Wild West, with the rules yet to settle. How can landlords make sure their bonds are not greenwashing? Keith Cooper reports. Illustration by The Red Dress

Housing associations seeking finance have taken a keen interest in three societal virtues of late: environmental sustainability, social good and good governance. They are the E, S and G of so-called environmental, social and governance bonds, which are a relatively new kind of loan that requires evidence of the good that associations do in these areas.

Of the three, one stands out as trickier and riskier: the E for environmental. Borrowers of ESG bonds – though not housing associations yet – have been accused of misleading their lenders about environmental claims, a malpractice known in the field as ‘greenwashing’.

As a result, scrutiny of ESG has been on the up. The US Securities and Exchange Commission has tightened its screws with a dedicated enforcement unit, and lawyers here warn of a realistic prospect of litigation against ESG borrowers if their sustainability claims turn out to be misleading.

“There aren’t standardised ways of measuring things and holding people to account. It is a little bit like the Wild West at the moment”

So what are the risks to housing associations of taking out ESG bonds? How can they avoid claims of greenwashing from disgruntled investors?

These are not easy questions to answer because the ESG market is relatively new and methods of measuring environmental impact can be complex, ill-defined, and are likely to change as regulations respond to greenwashing problems that emerge.

“Concerns about greenwashing are, undoubtedly, a live concern in the corporate world generally,” says Patrick Symington, chief executive of MORhomes, a borrowing vehicle which helps housing associations access the bond market. “If you look carefully at what people are promising to do, there is a lot of lip service and some of the measures are pretty wishy-washy. There aren’t standardised ways of measuring things and holding people to account. It is a little bit like the Wild West at the moment.”

To help housing associations provide credible evidence of their progress on sustainability, MORhomes developed a sustainable housing assessment tool, backed by consultancy Ritterwald, and produces an annual report on how its borrowers’ loans meet its criteria. “We defined our system to allay concerns about greenwashing,” Mr Symington says.

He admits that MORhomes cannot guarantee what happens to the funds it helps raise for housing associations. “But we can say what is intended and we can do the sustainability assessment upfront and report on the use of proceeds afterwards,” he says.

“We are only just beginning to address the problem of how we improve the energy efficiency of existing buildings”

This positive view of the sector is shared by Naomi Roper, a partner at law firm Trowers & Hamlins, who has advised on several ESG deals. “It would be difficult to levy greenwashing claims against the social housing sector,” she says. “They have been doing ESG activities for a long time, just not badging them as such.”

This apparently comfortable position does not, however, give reason for associations to rest on the laurels of these positive views. ESG bonds are a form of ‘transitional finance’ – a so-called bridge between traditional and sustainable finance. Transitional finance aims to help businesses on their journey towards net zero, and housing associations are only on the start of what is widely expected to be a long and arduous one.

Housebuilding is widely accepted as a significant net producer of carbon emissions. Huge numbers of homes owned by landlords are energy inefficient, making them increasingly expensive for tenants to live in and a major source of carbon emissions. “We are only just beginning to address the problem of how we improve the energy efficiency of existing buildings,” says Mr Symington. “But we don’t yet know what the detailed regulations
or funding are going to be.”

Ms Roper says that no one expects housing associations to become ESG experts, but warns that they must work out ESG strategies for themselves.

“No one is expecting that you can do this overnight,” she explains. “But they do have to be aware that there is still so much work to do in this space, so much coming down the line.”

One area of potential difficulty down the line could be how landlords measure carbon emissions and prove how they are reducing them. During this transitional finance phase, bond issuers are “pursuing an objective which isn’t very clearly defined”, says Julie McDowell, an ESG specialist and chair of Blackwood Homes and Care Group. “At the same time, they have to be concerned about claims that they have met the requirements.”

The reporting requirements for most ESG bonds used by housing associations fall into two main categories. For use of proceeds bonds – the most common type in social housing – issuers must show that the money they have borrowed is linked to ESG benefits. The second type, sustainability-linked bonds, includes key performance indicators (KPIs) which issuers must hit or pay extra interest to the lenders.

“If you hit the KPIs, they might be considered too easy and seen as nothing more than a marketing ploy”

Gary Leadbeater, director of treasury and corporate finance at Clarion Housing Group, says the landlord opted for a ‘use of proceeds’ sustainability bond, through which it has raised £950m. “The majority of the industry has gone for use of proceeds bonds,” he says. “It is what client investors prefer. I know that we are building energy-efficient new homes and I know how much we spend. It is easier to demonstrate that we’ve met our sustainability criteria.”

Mr Leadbeater believes sustainability-linked bonds may be more vulnerable to greenwashing claims. “If you hit the KPIs, they might be considered too easy and seen as nothing more than a marketing ploy,” he says. “But then they might be stretching enough to change your behaviour and you still don’t hit them. That could lead to bad press and cost you an extra 12 basis points – a step up on your interest payment.”

Another difficulty of sustainability-linked bonds is the need for measures of environmental performance which remain credible for the duration of the bond – and they can last decades. “At the moment, I don’t think that measurement criteria is established yet. A lot of it is not long term,” Mr Leadbeater says. “Much of it is based around Energy Performance Certificate [EPC] ratings. Is that the right measurement? Will it be the right measurement in 30 years’ time? We need time to get this right rather than committing too early.”

Beyond Housing: a journey

Beyond Housing issued a £250m, 30-year ESG bond in May 2021 and drew down £165m.

Kevin Hanlon, chief finance officer at the housing association, says: “We hadn’t planned for an ESG bond originally, we had just planned a bond. But as discussions progressed with our advisory banks – Lloyds [and] RBS [Royal Bank of Scotland] – our bookrunners and Centrus, our treasury advisors, we chose to conduct an ESG bond.

“Our banks suggested an ESG approach to bond financing may have some advantages in the marketplace. One was that it could attract more investors because pension funds and other large investors are looking for this kind of environmental, social, governance, green kind of long-term lending.

“If you have more investors in the market bidding for your bond, or you can attract more investment, there’s more competition. If you attract more investors – there’s no guarantee – but there’s the potential that competition leads to a potential lower cost of financing.

“At the point of issuing the bond, we had some knowledge of the ESG market. We then went away with our advisors and learned a lot more.

“The ESG bond has helped us think more about our environmental and social commitments. It’s a significant loan for the business and so a high-agenda item for the organisation.

“At the back of our minds when we’re investing money, we are thinking now more, ‘ESG, ESG, ESG.’”

How to avoid greenwashing

Martin Watts, director of treasury at L&Q, believes that its £300m sustainability-linked bond is “potentially less susceptible to greenwashing”. “Going through the sustainability-linked mechanism, we feel that it’s a more powerful tool,” he told Social Housing, Inside Housing’s sister magazine, early this year.

Under its decade-long bond, L&Q would have to pay a penalty equal to 93.75 basis points if it misses any of its KPIs. To avoid this increased interest rate, it must, by March 2024, reduce its greenhouse gas emissions in two categories by a set amount, achieve an average score of 72 or above in its SAP energy performance rating – a measurement related to EPCs – and build 8,000 new homes, half of which are affordable.

“All three KPIs from the deal have challenging and ambitious short-term targets – under two years – to avoid making promises that are unlikely to be fulfilled,” Mr Watts says. “Utilising the short-term sustainability performance targets outlines that our commitment is in the near term, not just a long-run commitment.”

To avoid further any claims of greenwashing, housing associations must go beyond simply ticking the boxes written into their bonds, says Ms McDowell.

Investors will also be interested in their corporate culture, she says, pointing to several ways this might be examined. “You can look at how senior in an organisation the ESG and sustainability issues go.
How focused is the board on this issue? What does the board do to ensure performance and supervise strategy?”

Kevin Hanlon, chief finance officer at Beyond Housing, says the £250m, 30-year bond the housing association issued last May had driven it to think more about its environmental and social commitments. “The bond is a significant commitment; it’s a significant loan for the business and so a high-agenda item for the organisation,” he adds (see box above).

There is also much landlords can do to avoid greenwashing claims in the future, according to lawyers.

Debra Cooper, real estate banking partner at Shoosmiths, says housing associations should guard against pursuing bonds for lower interest rates unless they are doing so for the right reasons.

“Bond requirements should be being driven by the right people, for the right reasons, to do the right things,” she says. “You have to ask, ‘Who is driving the agenda and what agenda are they driving?’ If they are saying, ‘Do this, do that and it will be cheaper’, you could get into some tricky territory,” Ms Cooper adds.

Trowers & Hamlins’ Ms Roper says landlords should set the metrics attached to ESG and avoid taking ones off the shelf from their lenders. “Sometimes when you’re doing a deal, the bank will ask you to pep it up with some more metrics to avoid greenwashing,” she explains. “Don’t allow the ESG aspects to be introduced at the end of the deal. If you are going to do a green or sustainability-linked product, it can’t become a green product at the 11th hour.”

Housing associations should start, Ms Roper says, by asking themselves what they can “sensibly and aspirationally reach for”. “It is those things that you should put down in metrics,” she adds.

Overall, most ESG experts consider the risk of greenwashing claims sticking to housing associations as small – at the moment. But this is not no risk at all, and it is one likely to change as scrutiny and regulation is inevitably increased. “What you did three years ago could be tested against a tighter regime and unsurprisingly come up short,” says Ms Cooper.

What seems safe ground now, might turn shaky soon. While the regulations around ESG remain woolly, the onus is more on the borrowers of bonds to ensure their green credentials are sound.

“You don’t want to discourage ESG in any form; it is important,” says Jonathon Crook, partner in dispute resolution and litigation at Shoosmiths. “But there has to be some concern that the fundamentals are thought through carefully. I don’t think the controls are necessarily there to ensure that there isn’t a risk to investors.”

As housing associations continue their journey along the ill-defined path to net zero, the risk of greenwashing will not go away any time soon. It may even get bigger.

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