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How mortgage portfolio standards could heat up building renovation

Portfolio standards have helped boost renewables in the US and cut vehicle fleet emissions in Europe. A push is under way to use them to align mortgage lenders with EU climate targets.

The EU has a renovation problem. To meet the bloc’s climate targets, 3% of its buildings need to be renovated each year to reduce their energy demand. Currently, that figure is just 1%, of which only one-fifth are “deep renovations”, where energy use is cut by the 60% or more that will be necessary to ultimately decarbonise the EU’s built environment.

EU building renovation

Installation of external wall thermal insulation with rock wool on the façade of a multistory residential building. (Photo by sommthink via Shutterstock)

The European Commission is not blind to this challenge. In October 2020, it launched its Renovation Wave strategy, which aims to more than double renovation rates over the next decade. This targets 35 million building renovations by 2030 and requires €275bn ($318.2bn) investment each year – five times the €57bn invested in buildings’ energy efficiency in the EU in 2019, according to the International Energy Agency.

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There are limited levers policymakers can pull to deliver four million renovations a year – and, some argue, they will need to engage the financial sector to make it work.

“The natural rate of renovation doesn’t consider our climate and energy policies,” says Peter Sweatman, CEO of Climate Strategy, a Madrid-based consultancy. It wants the EU to introduce a mortgage portfolio standard (MPS), which would require mortgage lenders to improve the average energy efficiency of their mortgage portfolios over time by working with their customers, in line with the goals of the Paris Agreement.

An MPS is modelled on the renewable portfolio standards that mandate US utilities to source a growing proportion of their electricity supply from renewables, and the vehicle fleet emissions targets that require European carmakers to reduce the average tailpipe emissions of CO2 from the cars they sell.

Getting banks involved

Sweatman believes the finance sector has not been sufficiently engaged in the building energy efficiency policy mix. Banks hold €7trn of European mortgages. Unlike the hundreds of thousands of often tiny businesses that actually carry out building renovation work, they represent a relatively small group of entities to which regulation could be applied.

Crucially, an MPS would aim to use the millions of relationships banks have with their borrowers to encourage these to take on energy renovation loans, streamlining the process and potentially providing access to centralised low-cost finance.

“It is extremely sensible – and an underutilised pathway – to have energy efficiency improvements made through existing banking relationships and/or tied to existing mortgages,” says Matthew Ulterino, property investment project coordinator at the UNEP Finance Initiative. “If there is a plausibly implementable mechanism that incentivises banks and borrowers to improve energy performance and greases the capital flow, it is worth looking at and very much needed.”

“Mortgage lenders are the single most powerful and most impacted stakeholder group in the decarbonisation of Europe’s buildings,” says a Climate Strategy report making the case for an MPS ahead of an event on 14 October to discuss the issue. However, “the reality is that mortgage lenders are largely absent from the coverage of the [EU] Energy Efficiency and the Energy Performance of Buildings directives.”

Taxonomy opportunity

What is in it for the banks? Sweatman notes that the fees they could earn from the €275bn in finance needed would run to €2–4bn each year. Greener mortgage portfolios would allow them to demonstrate greater alignment with an EU Taxonomy for green investment, which defines economic activities that are aligned with the EU’s environmental objectives. This would make their shares more attractive to ESG-aligned investors.

However, it would also improve the credit quality of their portfolios by helping their borrowers cut energy costs and therefore increase the disposal income they have available to service their debt. “Imagine if banks should sell a product that could get their customers a higher-paying job?” asks Sweatman.

In addition, the MPS as envisaged by Sweatman would carry “non-compliance penalties”.

Some leading banks are voluntarily adopting policies or offering products that have the same outcome as an MPS – namely, gradually improve the overall energy efficiency of their mortgage book. The Climate Strategy report cites mortgages offered by Triodos that carry a discount on the rate linked to the environmental performance of the home.

Banks already on board

Dutch bank ABN Amro, meanwhile, has set a target to bring its €185bn property loan portfolio up to an average ‘C’ Energy Performance Certification (EPC) rating by 2025 and ‘A’ by 2030. (Currently, its average EPC rating is ‘D’.) To do so, it provides a tool to let building owners and investors see how much they could save through energy efficiency measures, and outlines the products and subsidies available.

Fellow Dutch bank ING has a goal of making its mortgage portfolio “energy positive” by 2050 – that is, generating more energy than it consumes. In its recent climate report – the first time it has analysed climate risk and opportunity in a single study – it says banks should “play an increasing role making customers aware” of financing options for renovations – but the bank also sees a need for regulation.

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“It is evident better data and regulation is needed to make homes more sustainable and prepared to align with climate goals,” says Sandra Schoonhoven, the bank’s head of sustainability.

To this end, the bank is calling for EPCs that address the CO2 intensity of homes per square metre, as “this would result in a more transparent and effective assessment and allocation of the technologies and finance needs of each home”. Schoonhoven also calls for “increased government policies that would ease the climate transition and help alleviate homeowners’ doubts” about undertaking renovation work. One tool to this end would be access to property-backed renovation lending, with public guarantees.

Shareholder pressure

Regarding a Europe-wide MPS, Sweatman concedes that, while many banks have already set voluntary MPSs, not all banks will embrace additional regulation. However, institutional shareholders concerned about the climate risk posed by the bank stocks they hold see things differently, he notes. Currently, just 8% of leading bank balance sheets are aligned with the EU Taxonomy which, for mortgage lending, requires either a commitment to upgrade acquired properties to an EPC ‘A’ rating, or for the building to be within the top 15% in terms of its energy use, the report states.

Sweatman reports high levels of engagement with European policymakers in the MPS proposal. He wants to see it incorporated into the EU’s 'Fit for 55' legislative package, specifically in an update to the EU's Energy Performance of Buildings Directive (EPBD). The Commission’s proposal for a revised EPBD is currently in inter-service consultation; it is due to be published as part of a second batch of 'Fit for 55' proposals on 14 December.

While an MPS may appear to be novel, it is merely the application of tried and tested techniques to a new issue, Sweatman says. As well as portfolio standards in renewable power and vehicle emissions, energy efficiency obligations have been applied to energy retailers. “The Energy Efficiency Directive dealt with energy retailers; we are now talking about finance retailers,” says Sweatman.

“And if we have learnt anything in the last few years it is that, if you can influence those who control finance, you can have an outsized impact on the delivery of climate objectives.”

Mark Nicholls

Contributing editor Mark Nicholls, co-founder and former editor of Environmental Finance, specialises in sustainable finance and responsible investment, including ESG disclosure and carbon markets.