With governments and citizen activists demanding advancements in sustainable business, ESG initiatives are moving to the forefront of today’s market economy. In this environment, it is crucial for financial institutions to effectively manage ESG-related risks and capture ESG-centric opportunities as we see numerous examples in various domains of the financial services and insurance industries.
As the largest credit market in the world, the United States mortgage market is an ideal place to successfully deliver ESG-based assets to investors. Considering the efficiencies developed over the years in the mortgage process for trading mortgage loans between financial institutions, the housing finance industry is facing some challenges to be at the forefront of ESG initiatives. However, with increased government and investor focus on sustainable investing, the U.S. mortgage loan market is actively tackling these challenges and capturing related opportunities.
For example, lenders have begun rewarding borrowers for positive environmental practices through Green Loans (GLs) and Sustainability-Linked Loans (SLLs). GLs are structured in the same way as standard loans except that the loan proceeds are allocated to eligible green projects. A key difference between Green Bonds (GBs) and GLS is the lack of universally recognized Green Loan Principles (GLPs), like the bond market's Green Bond Principles 3 (GBPs). The GBPs allow compatible criteria, tracking and mutual recognition across markets, and national authorities who have facilitated the globalization of the GB market.
These GBs also require transparency on how sustainable projects are selected and how the funds are allocated. Sustainability-Linked Bonds (SLBs) differ from GBs in that they involve setting Sustainability Performance Targets (SPTs) for the borrower (i.e. measuring a reduction in greenhouse gas emissions, improvements in energy efficiency). Furthermore, SLBs proceeds do not need to be allocated exclusively to green projects thus providing more flexibility.
The secondary mortgage market and its investors reacted very positively to the eMBS announcement for ESG disclosures. eMBS provides Mortgage-Backed Securities market participants with reliable and cost-effective internet-based access to mortgage data and analytics. Both Fannie Mae and Freddie Mac are disclosing ESG securities on monthly basis. Freddie Mac and Fannie Mae have both initiated green bond programs to help create a positive environmental, social, and economic outcome for families and communities through responsible mortgage finance. The overall goal is to incentivize property owners, lenders, and investors to make environmental improvements to properties.
During 2020, Fannie Mae expanded their Green Bond Business to include Single-Family issuances, developed a Sustainable Bond Framework and issued their first Social Bond1.According to their latest green report2, Fannie Mae issued $13 billion in Multifamily GBs during 2020; overall Multifamily GS issuances total nearly $88B. Single Family GB issuances during 2020 totaled $94 million.
Freddie Mac has purchased $45 billion in green loans from its network of lenders. Estimates indicate that this program has resulted in efficiency improvements for 1,600 multifamily properties and lowered utility costs for 450,000 units nationwide3. In addition, their Multifamily impact bond strategy4 further splits the bonds into Green, Social and Sustainability bonds, and reports in detail on each of them.
As investors and regulatory bodies become more attuned to ESG concerns, the financial services industry is now seeing capital allocated based on ESG information and ratings. ESG is becoming the “industry standard” as consumers gravitate towards brands that address ESG issues in ways that align with their own values. As ESG reporting continues to evolve, firms that innovate more quickly will race ahead.
Recommendations for financial organizations to advance the ESG agenda and stay ahead of the competition:
- Ensure the firm is prepared to manage all aspects of the ESG challenge and has a strategic approach to Green, Social and Sustainability to promote ESG benefits to their investors
- Align to an ESG ratings provider or an ESG data aggregator organization so that the company’s ESG performance can be measured and tracked relative to other firms
- Consider the attributes of ESG data, which are hard to track and still evolving, in your company's data management standards and methods, especially when supplemented by third party data
- Create transparency for improved ESG data management; encourage the better use of ESG global data assets for sustainability which in turn will lead to better financial and societal outcomes
- Create education programs to inform their stakeholders internally and externally about ESG and how it is going to impact “Business as Usual”