ESG and Green Finance – this is just the start of the journey

Green Finance

The need to respond to the ESG (Environmental, Social & Governance) agenda and the pressure being placed externally on hospitality by customers, employees, shareholders and stakeholders to become more sustainable – is all set to escalate.

To secure financing for a hotel development or property acquisition, principals are now required to make disclosures pertaining to ESG, and there is also more pressure on financiers to invest sustainably. Though there is currently no global standard or scoring method to measure ESG performance – international standards and Financial Credit Ratings that evaluate ESG activities are now being prepared. This will have a direct impact on the availability and cost of borrowing in the future.

According to data compiled by research company BloombergNEF (BNEF) for its 1H 2022 Sustainable Finance Market Outlook. Volumes of sustainable debt surpassed $1.6 trillion in 2021 alone, more than doubling 2020’s end of year value. The fastest growth for sustainability themes in debt issuance last year came from sustainability-linked loans and bonds, which are instruments for which repayment is tied to the achievement of institutional ESG targets, such as the reduction of greenhouse gas emissions. These saw more than $530 billion issued in 2021 on their own, compared to only a quarter of this value in 2020. They came from industries such as financials, consumer discretionary companies and utilities.

In addition, to sustainability-linked instruments, sustainable debt includes funds borrowed for specific ESG projects, such as renewable energy build. Green bonds, raised for environmentally beneficial activities, saw more than $620 billion in issuance in 2021. Overall, green bonds were the largest contributor to the overall sustainable debt market, making up 45% of the $4 trillion of sustainable debt issued through 2021.

Andrew Harrington, Co-Founder of award-winning boutique investment bank  AHV Associates,  which offers a range of Capital Raising, Merger and Acquisition services across the hospitality sector, explains what is happening in the Green Finance market and what lies ahead for the hospitality sector.

I believe the ESG / sustainability agenda within hospitality is currently being driven by the consumer – a ‘sustainable’ hotel means whatever the customer wants it to mean. If you can come up with a good story as to why your hotel has invested in a particular green initiative or say “we are committed to net zero carbon” customers are willing to pay a small premium to experience that.

The question is, whether or not the claims are consistent with ESG Group Finance Standards, which actually don’t exist right now. We don’t know whether or not the measures that hotels are taking actually do contribute to net zero. Even so, currently, lenders and investors are keen to be a part of the narrative.

I think it will be at least five years before international bodies will have defined what it is we mean by sustainable real estate or sustainable hospitality, and what is really meant by ESG in terms of verifiable measures. It’s happening right now. Various Building Standard Bodies are on top of this and International Accounting Standard Boards are preparing a set of accounting measures which will assess the level to which a particular business or organisation they’re auditing, complies with green regulations in the near future. Furthermore, the EU are developing a set of standards (‘taxonomy’ in EU speak) and various financial market organisations e.g. International Capital Markets Association (ICMA) and Loan Markets Authority (LMA) have put in place voluntary guidelines for promoting transparency and consistency in definitions and reporting for the financing of green projects. However, it is still early days.

Once this process matures, you will get the rating agencies such as Standard & Poors, Moody’s and Fitch producing financial scores for companies upon their ESG deliverance. These ‘big three’ credit rating agencies have historically had excessive influence over lending decisions, conditions and interest rates of sovereign debts. Once that happens, you’ll get a huge shake up in the lending market. It’s all being put in place currently; I think Green Financial lending is really in its infancy. Currently, soaring energy prices are driving the hotel and hospitality sector to focus on energy conservation. Investment in facilities management systems can really help to manage energy usage and there’s an instant ROI. For most, there’s a large investment that needs to be made in solar, wind and heat pumps – and with repurposing and relevant planning permissions required – it’s a longer-term decision.  For this type of investment, you need to be able to assess the payback, there has to be stability in the energy market. I think those sorts of investments will come back around again but, with current high energy costs, it’s all about just cutting costs right now.

In the UK recently, in terms of lenders, we’ve witnessed a slowing down of transactions due to economic and political turmoil – none of the commercial banks like instability. But we are now seeing signs of transactions picking up. There’s a huge amount of money in the market, I expect a lot of transactions will be happening in the first quarter of 2023. It really is very, very different to ten years ago – when the banks were really stressed and there was not a lot of money in the debt markets.  Currently, the overall cost of money has gone up because of the variable cost of the loan – interest rates have gone up. So, typically, banks charge a spread, plus the bank rate. Now the bank rate has gone up, the spreads are going to come down because of the way too many assets are held, and to be honest, that’s a pretty good shape to be in. The cost of capital has gone up, but the hotel sector is resilient – especially at the luxury end of the market – which you can’t say about a lot of sectors. There’s always been a scalable, pricing system in hotels, so income can be safeguarded. Plus, there will always be a market for hotel real estate. Most lenders that have green credentials have been paying lip service to it. Once the ESG standards and ratings have been set, capital adequacy requirements will depend upon the degree to which the borrower is ESG compliant.

Hoteliers and developers need to be currently encompassing all manner of environmental considerations to put themselves on the road towards being ESG compliant – whatever that will mean eventually. ESG will be a valuable asset which you can use to get higher Annual Daily Rates (ADRs), occupancy and thence, higher valuations and lower funding costs in the future.

The sector is facing a combination of mitigation and adaptation, which will have social impact in terms of reducing carbon emissions, or not. It’s only going to accelerate over the course of the next decade or so – it is happening. But the academics will opine that it’s not happening quickly enough. We are entering a transformation period, in five years’ time, we won’t be having this conversation about sustainable financing, because it will be the norm.

Andrew Harrington, Co-Founder of AHV Associates

Andrew started his career in investment banking at Barclays in 1988. Between 1989 and 1998, Andrew worked at Salomon Brothers and was rated as the number one sector analyst globally in all the major corporate and institutional investor surveys. In 1998, Andrew founded a telecoms company, providing telecommunications services to residential and business customers. He successfully grew the company to £25 million in revenues, and over 60,000 customers by the end of 2000.
Andrew has a degree in Natural Sciences from the University of Cambridge and has a DPhil in Theoretical Physics from the University of Oxford.

Our thanks to Andrew Harrington for taking the time to speak to us.