Opportunity awaits - Understanding Asia's green building bond journey

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Green bond issuance should skyrocket over the next few years in the Asia-Pacific region, and this trend will be significantly driven by the construction of green buildings, according to projections from the IFC. However, the development of green buildings (and green bonds) are just at the beginning of a long journey. The success of this journey will require active collaboration among designers, builders, tenants, building owners, regulators, and other stakeholders.

Green buildings – a specific type of use of proceeds for green bonds – are buildings that incorporate a mixture of energy efficiency and renewable energy approaches to lower carbon emissions. In Asia, building is set to skyrocket over the next two decades as a result of urbanization, economic growth, and population expansion. Globally, cities represent almost 80% of greenhouse gas emissions, and urbanization is increasing, particularly in Asia. The world's building stock accounts for 40% of the global emissions of greenhouse gases. As a result, governments are beginning to incentivize both green buildings and green bonds, as a way to prevent this significant level of development from contributing to climate change.

Jean-Marie Masse, IFC Globally, since the green building designation was launched in 2017, there has been nearly $60 billion in green bond issuance for green buildings, and the amount issued in Asia is growing. The first article in this two-part series in Environmental Finance explored how the market for green bonds to finance green buildings is developing in emerging Asia. This second article looks more closely at the underlying assets themselves – the green buildings. Having a green building to finance with a green bond (or a portfolio of green building loans to transform into a green bond) requires a set of relationships to be in place – with governments and regulators, construction companies, building component suppliers, and architects, for example.

Once a building (or a portfolio of buildings) is ready to be financed or refinanced, it will be subject to governance through a green bond framework, as well as independent reviews and impact reporting. For a green building to be financed through a green bond, all of the relationships must have worked together to create a building that will then meet the subsequent governance requirements. Green bonds start with green buildings, and green buildings need a whole community of stakeholders to make the green a reality.

Greening at the beginning

Today, building green simply cannot be an afterthought in a project – it must be baked into the design of the building from the very beginning of the entire process. When retrofitting a building to become green, multiple considerations come into play. However, getting the entire value chain of a project to "think green" from the start continues to be an issue, and of course has an impact on the ability to complete green financing at the end. "These are early days for green bonds for green buildings," says Jean-Marie Masse, chief investment officer at the IFC in Washington DC. "There is a need for all of the stakeholders to factor in the financing opportunities offered by green bonds. These stakeholders include the architect, the developer, the building owner, the banks, and those who issue the bonds in the capital markets. There is such a growing opportunity for green bonds to raise financing at scale for green buildings." The IFC is working with the private sector to help foster green action across this entire value chain. (See figure 1.)

Luckily, in many places around the world, green buildings are starting to connect up those individual stakeholders in a conversation – a conversation driven by outcomes that is creating its own momentum. For example, there is a growing body of research and experience that shows green buildings make better investments. Green buildings often have better light and air quality, which can mean lower sickness levels – up to 15%, says Christopher Flensborg, head of climate & sustainable finance at SEB. He points out that this type of "soft factor" isn't just good for society and a plus for green activity, but that it also has strong economic benefits – lower sickness levels will mean higher productivity levels for a company occupying the space.

Figure 1: Creating a market for green buildings

Flensborg adds that green buildings globally are starting to show lower vacancy rates and higher resell values. "There are a number of side effects of green buildings that are very positive for both society and for the economics of the building," says Flensborg. Better quality tenancy rates turn into improved cash flow for the real estate company, which translates into a higher quality asset for an investment portfolio – a more measurable "hard factor". As a result, design, construction, developers, financing teams, and other stakeholders are all brought into dialogue.

In Asia and other emerging markets, where so much new construction, and retrofitting of existing buildings, is expected to happen over the next decades, ensuring these stakeholders connect to create an economic argument for green buildings is a priority for policymakers. Says the IFC'S Masse, "the IFC is working hard to foster these connections through a range of initiatives, from helping governments to make their building codes greener through to investing in Asia's green building green bonds ourselves."

Greening through government

Green bonds need green buildings – but the construction or retrofitting of those buildings needs to be supported by policies, building codes, and recognition programs in individual jurisdictions. It is still very early days in the Asia-Pacific region, where government building regulation and enforcement has been uneven, historically. For green bonds that finance green buildings to succeed, government support needs to evolve.

Certainly, Asia's governments have incentive to green their building regulations and policies now. The first article in this two-part series discussed the demand for new building, and how that growth will occur predominantly in emerging markets – and particularly Asia. The development of green buildings is being driven by rapid urbanization in Asia, as well as economic development and deep concerns about the climate impact this additional built environment could have.

The built environment around the globe is already a challenge when it comes to climate change. Buildings account for about 20% of global greenhouse gas emissions, and these emissions have continued to rise at a rate of 1% since 2010, according to the OECD. The new construction is anticipated to add significantly to the problem of climate change unless there is a switch to green buildings. A December 2017 report from the UN Environment Programme and the International Energy Agency (IEA) says that over the next 20 years, more than half of new buildings expected to be built before 2060 will be constructed. Unfortunately, two-thirds of those additions are expected to occur in countries that do not currently have mandatory building energy codes in place. According to the UN and IEA report, just 62 out of 195 countries that submitted information have building energy codes.¹

As a result, it's not surprising that one key area where global policymakers are focusing on is getting countries – including those in Asia – to implement a range of green building codes that cover energy, water, emissions, and other green concerns. "The way that green policies are driven in most countries is through the building codes, so it is important that these are well-defined and stringent," says Prashant Vaze, head of policy and government at Climate Bonds Initiative (CBI). For example, in Europe, building codes have been strengthened in a predictable way over time so that they support green policies.

Prashant Vaze, Climate Bonds Initiative However, green building codes alone are not enough – buildings also need to have clear and reliable labels on them that convey how well the building performs once it is completed. "We need public sector work on labelling," says Sean Kidney, CEO of the Climate Bonds Initiative.

This continues to be a challenge even in OCED countries – for example, the European Union has an energy performance certificate (EPC) program but it is implemented unevenly across the member states, says Kidney. Supporting countries to fully implement the EPC program would result in more European green bond transactions because investors could have more faith in the reliability of the greenness of the underlying assets. Globally, says Kidney, governments have to "say they are not going to accept poor quality buildings any more. We are not quite there yet. We need to do more work on criteria and building regulation."

One country that is at the forefront of implementing a green building and construction industry regulatory infrastructure is Singapore. Singapore is particularly conscious of the potential impacts of climate change because the country is on a low-lying island. "Much of the country lies only 15 meters above the mean sea level, and about 30% of the island is less than five meters above sea level," says Esther An, chief sustainability officer of City Developments Limited, which launched Singapore's first green bond in the spring of 2017. "The authorities have been preparing early to safeguard Singapore." The country's Green Building Masterplan aims to green 80% of all buildings in Singapore by 2030 – the country is currently at the 40% mark.

The country's Building and Construction Authority (BCA) made its green building code mandatory back in 2008, and has green building programs such as the Singapore Green Building Council's BCA Greenmark.² The Greenmark is composed of four sections: climatic responsive design, building energy performance, resource stewardship, and smart and healthy building. The certification also has a bonus section on advanced green building efforts which recognises sustainability efforts that go beyond assessment requirements – this gives the government the ability to try out new policies and to see if new technologies work, says Vaze.

Another country that has focused strongly on driving building energy efficiency through policy is China. According to a new report³ from the IEA, policy coverage for non-residential buildings is 63% and is 33% for residential buildings. The report says that this "reflects China's ambitious building codes and appliance standards. These have been crucial to counteract the increase in energy use resulting from rapid construction activity and higher rates of appliance ownership."

Other jurisdictions around the globe need to implement similar approaches – something that the World Green Building Council⁴ is working towards as well. Says Flensborg, "The ability to showcase that these buildings are managed in accordance with these standards and are taking consideration of not only hard but also soft factors is going to be important for how investors are going to classify their assets."

Vaze adds, "It's really important that we design these building certification systems in a way that investors and tenants are really looking for. They are looking for things like, is the building going to be resilient to climate change? Will it be in sympathy with the zero carbon buildings agenda that the world has?"

The IFC is working to foster government policymaking in a range of ways, including its EDGE program.⁵ The IFC's EDGE initiative works with regulators to develop green building codes that are low-cost for the private sector to implement, easily enforceable, and help to prevent climate change. EDGE helps countries to raise building efficiency standards, promote policies to leverage private sector innovation, and provide support once codes are established. In Asia, the IFC has helped to develop regulations in Bangladesh, Indonesia, the Philippines and Vietnam.

Looking to the future, one way that governments might consider supporting green financing is through lower regulatory capital charges for green bonds and other forms of green financing. Some regulators are beginning to analyse green financial debt and say they are finding that statistically default rates are lower than for similar, non-green assets, says Pierre Rousseau, senior strategic advisor for sustainable business at BNP Paribas. China is one of these jurisdictions, and is actively considering lowering the capital charge. Says Rousseau, "having a lower cost of capital would provide considerable incentive for green financing."

Building green bond frameworks

Esther An, City Developments Another important area of policymaking for governments are green bond frameworks. While these are aimed at issuers in the financial sector and have to align with financial market considerations, they also have to be integrated with the country's building codes, energy and carbon emissions policies, and other relevant green factors. Since the launch of the Green Bond Principles in 2014 – a foundation document for the green bond industry – a number of countries have launched guidance based on the principles – as well as on the Climate Bond Initiative's (CBI's) Climate Bonds Standard – for their jurisdictions⁶.

In Asia, China launched its framework in 2015, while Japan introduced green bond guidelines in March 2017. Later in 2017, the ASEAN group of 10 southeast Asian countries rolled out their own framework through the Asean Capital Markets Forum. Meanwhile, the European Commission is looking to create its own taxonomy to define what is green and to act as a framework for green financing within the EU. This taxonomy project will likely publish a first draft in 2019 – and there is little doubt it will influence the drafting and revision of frameworks around the globe.⁷

New frameworks are being launched all the time, and existing ones are being revised as policies, climate change technologies and the capital markets evolve. Individual issuers also have to develop their own green bond frameworks as part of the governance program that supports the issue. These frameworks generally are based on the Green Bond Principles, regional or national guidelines the issuer is subject to, their jurisdiction's regulations, and the organization's own climate change policy goals. "Organizations seeking to launch a green building green bond should ensure they are familiar with all of the frameworks that would apply from the very start of their project's design," says Masse. "Trying to retrofit 'green' into a project is counterproductive. Green should be a building project priority from Day One."

Independent reviews becoming a requirement

An important green bond issuance practice that building projects should be aware of from the start are independent reviews. Independent green bond reviews are becoming an increasing part of the overall landscape, and they can have added dimensions in a green building financing because of the nature of the physical asset. Essentially, the building has to be designed to ensure it can deliver on the various green obligations it has signed up to.

Reviews can take many forms, looking at the different levels of green governance around a transaction. One form of review is an assessment of an issuer's green bond framework – for example, DBS Bank had Sustainalytics review its Green Bond framework before its green building green bond issue in the summer of 2017. In the framework, DBS said that all of the green buildings funded by green bonds would adhere to a recognized green building certification scheme, above a certain level of compliance.⁸ In its opinion, Sustainalytics viewed "DBS' eligibility criteria for use of proceeds under its green bond framework as credible and robust. All of its use of proceeds categories are recognised as eligible by the Green Bond Principles 2017."

Green bonds for green buildings can also have an external review conducted on the green credentials of the use of proceeds. For green buildings, this involves ensuring that the particular green bond issue meets the green bond framework's criteria. So, for DBS's July 2017 green bond issue, EY reviewed the proposed use of proceeds and concluded that they were consistent with DBS's green bond framework.⁹

When the Green Bond Principles were launched in 2014, just one-third of issuers were obtaining an independent review of their green bond issue prior to launch, according to Peter Munro, director, green and social bond principles, at ICMA. Today, he says, globally well over half of issues have an independent review. According to the Environmental Finance Bond Database, Asian green building green bond issuers are right on track with this trend, with 58% of green building green bond issues since 2017 obtaining an independent review. Sustainalytics has the bulk of the market share for these transactions, completing external reviews on 60% of the issues.

These external reviews are gradually becoming the norm for green bond transactions because they help potential investors to become comfortable with the deal and its underlying assets. "A survey earlier this year of investor members of the GBP shows there is a sizeable constituency that already require an external review, and a range of others who find such inputs helpful," says Munro. Regulators are encouraging the use of external reviews too. The ASEAN Green Bond Standards¹⁰ encourage issuers to obtain an external review, while in China these reviews are recommended, which in practice means they are, for all intents and purposes, required. As a result, it's important for the entire building design and construction process to be aware of the need to ultimately meet the requirements of an external review.

The external reviewer industry is nascent and is developing rapidly, both in terms of the number of external review firms and their review methodologies. There is a growing drive for greater transparency and accountability among external reviewers. A Green Bond Principles publication in June 2018¹¹ provides some initial guidance¹² for external reviewers of transactions. "We now have some standards of practice in place which should put the sector in good stead," says Munro. "They partly recognize what is already happening, but also are a signal to those who are recent entrants to the sector that they will be expected to perform at a certain level."

In addition, regulators around the globe, including the EU, are looking at potentially instituting regulatory requirements such as registration of external reviewers – in much the same way that credit rating agencies are regulated. The IFC and the Sustainable Banking Network – which recently launched a toolkit for regulators seeking to develop green bond issuance¹³ – are looking at these issues as well.

For green building green bond issuers in emerging markets, external reviews of transactions can significantly enhance the appeal of the deal. So, it makes sense that green building projects should also consider the requirements of an external review, particularly if the project is in an emerging market. Some jurisdictions are helping to foster the use of external reviews by offering financial support for this process for green bond issuers. For example, the Monetary Authority of Singapore (MAS) launched a program in 2017 in which issuers of green bonds can apply to for up to 100% of the costs of an external review, with a cap of SDG100,000 ($71,400).¹⁴

"A report by the Sustainable Banking Network indicated that one of the areas of shortfall for green bonds in emerging markets is investor demand," says Munro. "Some of the concerns or constraints that investors from developed markets traditionally bring to emerging markets have been around credit quality and transparency. In such circumstances, obtaining improved transparency and accountability on the part of issuers is surely beneficial, even if it is not a magic bullet. So external reviews can certainly help improve the proposition, assuming they are done well."

Impact reporting on the rise

Another area where the additional transparency requirements of green bonds require more forethought during the design and construction of a green building is in impact reporting. Impact reports, usually provided annually, update investors on how well the underlying assets of a green bond issue is adhering to the metrics provided in the deal's prospectus and other marketing materials.

"What gets measured gets managed," says City Developments' An. "Sustainability reporting drives corporate reporters to track performance, identify gaps for improvement and find opportunities for innovation and solutions to raise performance. It serves to raise transparency and communication with investors and financial institutions who are key stakeholders involved with green finance." For example, City Developments was the first Singapore real estate company to set a challenging greenhouse gas emission reduction target of 59% by 2030.

So, for a green building, an impact report could discuss the structure's overall energy efficiency indicators as well as the success in using renewable energy. As with frameworks and external reviews, it makes sense to consider the quality of the impact reporting – for example, what metrics are to be included – during the building design process. For example, technology can be included to make the collection of metrics easier, or building design can be targeted toward delivering on specific metrics.

Today 70% of green bond investors require impact reporting, and this level is expected to rise over the next few years, according to a June 2018 ICMA survey.¹⁵ Munro says this is a sharp increase over three or four years ago, when some investors were asking for this but it was not a requirement. Environmental Finance has learnt that not only are asset owners increasingly demanding impact reporting; part of the reason for this increase in demand for impact reporting is the growth of regulatory compliance challenges for firms around climate change. For example, France has a climate reporting law, Article 173, which creates a comply or explain obligation for the buy-side to report on their environmental footprint. Impact reporting gives these investors "metrics to put into that analysis," says Munro. "If they are concerned about climate risk and opportunity, then impact reporting – particularly the carbon aspect – is featuring prominently in their thoughts."

When the Green Bond Principles were launched in 2014, only one-third of issuers were supplying impact reports – today more than half are, says Munro. He adds that 70% of GBP/SBP investor members surveyed this year are demanding impact reporting by issuers. One issuer who released their first impact report over the summer is DBS – the report¹⁶ discusses the use of proceeds for its first US$500 million green bond, issued in July 2017. All of the net proceeds of the issue were allocated to green assets that are part of DBS' financing of a green building – Marina Bay Financial Centre Tower 3 (MBFC T3), a commercial property in Singapore certified Green Mark Platinum by the BCA. The impact report discusses DBS's approach to green financing, awards that the building has won, and provides an energy efficiency metric.

To quantify the CO2 impact of the green bond, DBS benchmarked the actual energy performance of the MBFC T3 building against non-green commercial buildings in Singapore. According to DBS, in 2017, MBFC T3 achieved an energy use intensity (EUI) of 185 kWh/m2, compared to the average EUI of 260 kWh/m2 for non- green commercial buildings in Singapore. While this is a fairly straight-forward metric, most industry experts expect metric reporting to increase in sophistication over time. As a result, building designers and builders will want to take into account not just the green performance of a building, but how this can be evidenced through system monitoring and metrics.

In time, green bond experts expect these impact reports to increase the number of metrics they supply and become more detailed as investors' governance demands evolve. "It's important that you design it, you build it, and you measure it afterwards," says Vaze. "Ideally you want to publicize how the building is performing." It's possible that in Asia the publishing of building metrics will be standardized, as it is in the UK, where building energy performance certificates are all available online.

Institutional investors are also expected to drive more disclosure. Other industries will soon have climate disclosure requirements too – more broadly the Task Force on Climate-related Financial Disclosures¹⁷ is exploring the physical, liability and transition risks associated with climate change and what constitutes effective financial disclosures across industries. As disclosure around climate change factors becomes more commonplace, the amount of information expected from green building green bonds will likely also rise. "We see this as a positive for emerging market issuers," says Masse. "The more information issuers can provide around their green credentials, the more comfortable investors will become generally with participating in their issues."

Building green, financing green

Christopher Flensborg, SEB Overall, the green bond market, particularly for green buildings, is in it's early stages and is experiencing tremendous growth in Asia. Getting the pieces in place for a green building as well as a green bond can take more work than a traditional building, or bond offering, might do. As well, evolving approaches by regulators, the construction industry, and the markets can require expertise to ensure a project goes smoothly.

So, is this all worth it? One recent issuer says it is. Issuing a green building green bond may seem like more work, compared with a normal issue, and it is. "There is a hurdle you have to cross," says Yulanda Chung, DBS Bank's director and head of sustainability. "But that hurdle is pretty low because there is a lot of help at hand for companies doing a green bond. The assurance providers in most ASEAN markets are very knowledgeable about the process and they can advise clients. And the costs involved, in the grand scheme of things, are negligible."

There are also clear benefits from green buildings and green bonds for a company's reputation, its cost base over the longer term, and its employees. Going green can be exciting in other ways, too. "Green bonds have been building bridges," says Flensborg. "That means that the interaction, cooperation and education of the different sectors has been taking place because of green bonds." He adds, "there is going to be more progress. That is a no-brainer."

It's true that progress needs to be made in the region across a variety of fronts. "Building energy codes need to be more stringent, they need to be updated, and there needs to be an incentive structure

that rewards innovation for the right things," says the CBI's Vaze. "The icing on the cake would be a richness of data" on building performance and other green metrics.

However, the future in Asia is looking green – both for new construction across the region as well as for the financing of those buildings through green bonds. As a result, the investor base is growing – an example is the launch of the Amundi Emerging Green One Fund, the world's largest green bond fund, in March 2018. Says the IFC's Masse, "This is the beginning of something very big and transformative for the region. Asia has the potential to become a very big market for both green buildings and green bonds. It has very exciting possibilities for the future.

References

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