Banks and lenders can step in to push ESG reporting without waiting for new laws
Environmental and Social Governance – or ESG – has dominated debates in the business world. But it’s difficult to separate the volume of the talk from concrete results. There is now a framework for companies to disclose climate-related risks and opportunities, but these reporting rules are only mandatory for around 1,300 of the biggest businesses in the UK.
Those who do have to file reports are only required to calculate exposure to climate risk, not demonstrate results – either on the sustainability front or for the other two parts of the ESG equation. So while legislation started momentum in the right direction, the onus to do better still very much remains the prerogative and responsibility of individual businesses.
It’s a similar picture in the world of real estate. The rise of environmental and social strategies has created an attitude shift among institutional investors, who will only buy ESG compliant stock, and large corporate tenants, who typically look to occupy equally compliant buildings. But this mindset has yet to trickle down to the wider market, particularly smaller occupiers and investors.
Here, lenders have a significant amount of influence and should be using their unique position to push for greater outcomes. As one of the main sources of capital for small and medium-sized developers and operators – who may not be as compelled to formulate an internal ESG strategy as established players – lenders can structure the terms of their loans to influence behaviour in the wider industry.
They can do this with a carrot and a stick – and both need to be employed to ensure maximum effectiveness. We’ve seen the emergence of a carrot approach in the wider market, with many lenders offering margin benefits on loans to investors and developers that have a clear ESG strategy.
What’s less common is the alternative approach – which could involve refusing funding to companies that don’t have a plan to drive positive ESG results, or offering penalised financial terms to lend against assets that can be considered to be “brown”. It’s possible that future regulation will be introduced to much the same effect, but this is an area where lenders can have an impact without waiting for the wheels of Westminster to turn.
This isn’t about the result of a moral crusade on the part of the lender, it’s about good business sense as well. Buildings with poor ESG credentials run the real risk of becoming stranded assets, and therefore lending money with no mind to how the asset will perform in the long term is a surefire way for lenders to end up with untenable loan-to-value ratios on their books. The reverse is also true – assets with strong ESG credentials will continue to prove popular with tenants as ESG-led thinking continues to spread both top-down (increasing regulation) and bottom-up (greater demand from tenants).
But implementing terms with any sort of accuracy and effectiveness requires detailed knowledge of the sectors in which lenders operate, an understanding of what best practice looks like, and an ability to navigate the alphabet soup of accreditation systems. Larger generalist and high street banks may not be well placed to truly understand good from bad.
Given the lack of a truly muscular regulatory system for mandating ESG outcomes, lenders find themselves in a unique position to be able to influence the market for the better. They would do well to take the opportunity – not only for their conscience, but for their balance sheets too.