There is significant noise around ESG factors and their role in various sectors. There are global efforts to develop universal taxonomies, standards and guidance, with a need to protect against greenwashing (the UK's financial regulator the FCA is consulting to guard against this).
Although a strategic pivot towards ESG compliance is no longer the new "next big thing" for loans, we do not think there is a clear understanding how ESG requirements fit in.
This article focuses on the financing of assets in the logistics sector across Europe, and how and why various metrics are actually being used in sustainable loan transactions.
We identify developing trends and where there may be scope for developers, operators, lenders and other investors to challenge the status quo, both in structuring, and at a more fundamental asset and business level.
We also consider more broadly why ESG factors are useful to the sector in terms of the value proposition and investment strategies.
If you would like to discuss any aspect of this, contact Richard Gibbard or Philip Abbott.
It is fair to say that Environmental, Social and Governance (ESG) has matured. In 2021, the UK Government set out its Net Zero Strategy: Build Back Greener, seeking to decarbonise the UK economy and target net zero carbon emissions by 2050. Societal and ethical lending and investment have also accelerated in the UK and Europe, responding to political and structural initiatives around factors such as corporate integrity, diversity and health and safety. Generally, the financial performance and long-term viability of assets and businesses across the economy as a whole is increasingly correlated to their sustainability.
Office buildings, commercial and residential property are readily seen as a natural fit for certain 'green' and sustainability metrics, but other areas of real estate are less understood.
The boom in e-commerce that followed the coronavirus pandemic accelerated demand for all categories of logistics assets. That in turn allowed ESG issues to gain traction as owners, operators and occupiers sought to reassess their needs alongside maturing sustainability strategies and a greater demand for future-proofed premises that could meet these standards for the whole lifecycle of a property.
It is not the purpose of this article to assess the quality or effectiveness of key performance indicators (KPIs) or ESG criteria. Indeed, a recent report on sustainability across the logistics sector in Europe identified that the primary driver for ESG action in the sector was the need to meet regulatory and legal requirements, rather than any particular environmental or social altruism.
However, it is fair to say that lenders and other investors, as well as developers, have switched on to the fact that a competitive ESG offering would be a significant commercial advantage. A report by CBRE in September 2022 considered eleven European markets, exploring the relationship between BREEAM sustainability certification, logistics yields and rents achieved. According to CBRE, logistics facilities with sustainability certificates are likely to benefit real estate investors financially and that assets with sustainability features are likely to protect values increasingly going forward.
Recent trends in the European real estate finance loan market
In 2021 and 2022 a number of significant loan deals were completed across the UK and Europe involving logistics assets. An analysis of those transactions that were made public gives some sense of how the sector is evolving when it comes to green or, more broadly, ESG-based lending.
Perhaps the most eye-catching transaction in value terms was Allianz and ABN AMRO's €300m loan to Intospace for its portfolio of six logistics assets in the Netherlands. Allianz Real Estate provided 90% of a €301 million, seven-year refinancing facility with ABN AMRO, as arranger, co-lender and facility and security agent, providing the remaining 10%.
The properties are strategically spread across the Netherlands near major transportation hubs and are let to blue-chip tenants and logistics companies. They are constructed to specific ESG and fit-out standards, assessed by Allianz's in-house logistics team.
From what we have seen in the market, KPIs in green or sustainability-linked loans (SLLs) are most often linked to interest rate margins rather than debt sizing, availability or hard covenants.
An example of this is another deal in the Netherlands, in December 2021 NSI N.V. amended and extended a revolving credit facility with ABN AMRO, ING, Rabobank and Belfius. Alongside a maturity extension the amended agreement introduced a sustainability-linked interest margin mechanism through which the margin would be adjusted, based on the borrower's performance against four indicators (see the end of this article for a glossary of terms):
- the percentage of buildings labelled at least “Very good” under BREEAM
- the percentage of buildings with European Energy Performance Certificate (EPC) 'A' Energy labels
- further sustainable investments as a percentage of capital expenditure, and
- the company’s GRESB rating.
The same approach was taken in the logistics sector in the UK in early 2022, when Aviva Investors agreed to an additional £40 million SLL with Urban Logistics REIT. It was the second facility Aviva Investors provided to Urban Logistics REIT following an initial £48 million SLL in March 2021.
The facilities were designed to align with Aviva Investors’ own Sustainable Transition Loans framework and permit interest rate reductions that would incentivise the borrower to work towards an agreed set of sustainability transition criteria.
The trend for funding that seeks to align with investors' ESG goals also saw a £120 million seven-year refinancing deal (September 2022) by M&G Investments with Big Yellow Group PLC. The funding was used to support Big Yellow's capital expenditure and "to drive ESG initiatives" across its property portfolio in London and the South East, including planned investment in solar energy in line with Big Yellow's Net Renewable Positive Energy Strategy.
Similarly, in November 2022 Leumi UK announced it had provided Northtree with a £12 million loan to refinance a portfolio of logistics warehousing, light industrial, and office assets. Northtree said at the time that it had "earmarked funds to help institutionalise the assets and improve their EPC credentials" which was "in-keeping with its ESG-focused philosophy".
Key buy-side drivers in the industrial and logistics sector are to increase operational efficiencies, reduce the environmental impact of logistics facilities and transport operations, and strive for carbon neutrality across the board. As such KPIs for SLL will often more specifically target and incentivise these areas.
By way of an example, in 2021 Allianz Real Estate, through its Luxembourg-based European debt fund, provided a £240 million loan to BentallGreenOak, working with Equation Properties, to develop a portfolio of eight prime logistics assets in the UK.
Each of the properties are in key and strategic locations with access to primary transport routes that aim to meet ESG criteria, specifically EPC A and BREEAM Excellent Certification.
The assets are also required to have a Carbon Risk Real Estate Monitor (CRREM) assessment to ensure they are in line with the UK's decarbonisation and energy reduction pathways.
Reducing waste, energy and water usage is another area where the logistics sector has been active. Buildings that use LED lighting and renewable or self-generating energy sources, battery storage and minimise water usage for example, will achieve high 'green building' ratings but there is scope to do (and measure) more. Similarly, using data analytics, smart technology, and automation can enable more efficient movement of inventory and maximise energy efficiency.
In February 2021, the fashion house Prada obtained an SLL with UniCredit that, among other things, included KPIs that were focused on:
- The regeneration and reconversion of production waste (for example into fertilisers or energy).
- Increasing the share of self-produced energy, by constructing photovoltaic (i.e. solar) energy systems to make its production and logistics sites in Tuscany near self-sufficient in energy usage.
In January 2021, Batilogistic, a designer and developer of warehouses, obtained a nine-year €222 million loan with a group of banks comprising ING, Banque Européenne du Crédit Mutuel, CIC Est, Groupe Crédit Agricole, Société Générale and BRED Banque Populaire to finance land and logistics buildings in various international markets.
In this case, interest margins on the debt were adjusted on the following KPIs:
- The proportion of LEED or HQE certified buildings in the borrower's real estate portfolio.
- The reduction of greenhouse gas emissions (by reference to the Greenhouse Gas Protocol) from warehouses owned by the borrower and operated by its sister company, FM Logistic in France.
- FM Logistic's position on the EcoVadis rating system.
While ING coordinated the transaction, Crédit Lyonnais (LCL) developed, and will subsequently assess, the ESG criteria.
Many of the publicly-announced SLL transactions in the logistics sector include KPIs that seek to enhance the ESG credentials of the underlying property assets, such as by reference to a GRESB score, sustainable building certification (BREEAM, LEED etc.), emissions reporting or other environmental data.
When abrdn’s AIPUT fund announced its £350m funding from Wells Fargo, it highlighted the investment as aligning with, and accelerating the delivery of, its Net Zero Carbon Strategy. The goal being to improve the portfolio’s energy efficiency by decarbonising the fund's operations at the property-level. The KPIs were set to help AIPUT deliver energy-efficient buildings that "attract and retain responsibly-focused tenants and … staff, improving the quality of the built environment with new features that reduce operational costs and environmental impacts".
In the UK, ageing logistics property is a significant factor. Assets that are most likely to score highly for sustainability are new-builds. Retro-fitting ESG credentials into older stock is challenging and expensive when compared to a design and construction programme that is calibrated for a specific ESG outcome. While newer developments will attract SLL funding more readily, refurbishment and occupier fit-out could be incentivised.
It is possible that current concerns on energy security and prices may provide a more immediate spur to action as in November 2022, at least one logistics operator reported a "materially higher level of engagement with occupiers on solar PV installations across our portfolio".
However, there have been other SLLs in the sector that have sought to go beyond an immediate focus on the built environment. The climate implications of logistics transportation mean that operators are increasingly looking to reduce or even eliminate emissions in their fleets.
When DHL introduced its sustainability-linked framework in November 2022 it was interesting to note that the vast majority of its global greenhouse gas emissions arise from aircraft, vehicles, vessels, and logistics sites that DHL and its subcontractors operate globally. Around 70% of total emissions are attributed to air transport, 22% to road transport, 7% to ocean freight and only 1% to the operation of its buildings.
One transaction that specifically sought to address the transportation impact was the Raben Group's 2021 financing by way of a €225 million five-year SLL, with a group of seven banks including BNP Paribas Bank Polska S.A. as sustainability coordinator, ING Bank Śląski S.A. as agent, and Coöperatieve Rabobank U.A. as documentation coordinator. The loan also represented one of the first club deal SLLs in the European logistics industry.
The margin on this occasion linked to Raben achieving a set of five KPIs covering ESG issues for the road transport and logistics sector. The KPIs (set out below) represented a mix of both internal KPIs and external ESG assessments that sought to address material ESG issues for Raben across its business and operations, as set out in its internal 2020 Sustainability Report, being:
- A 30% reduction of emissions in Raben's facilities
- A 10% reduction in emissions in transport activities
- That 96% of its fleet complies with Euro V and VI emission standards
- Reductions in road freight through increased transport efficiency
- Updating and enhancing the CO2 calculator used in transport activities to reduce greenhouse gas emissions.
Even when expanding the metrics beyond buildings there has been criticism that a narrow focus on decarbonisation does not tackle the material ESG issues of stakeholders, which are often not limited to CO2 emissions.
The 'social' and 'governance' elements of ESG are less trumpeted in the real estate sector than the 'environmental', and this extends to logistics. While there are efforts in some instances to drive KPIs around the health and well-being of building occupants or those in close proximity (e.g. through sensitive and sustainable land use), there are other areas of 'social' and 'governance' performance than can be measured and enhanced.
In Chile, the International Finance Corporation part of the World Bank Group provided $70 million in finance for AGUNSA, being the first SLL to a company in the logistic services sector in the country. Significantly, the lending contemplates performance targets related to, among other things, gender equality and board diversity.
AGUNSA's commitment is linked to the SDGs. Specifically, as to SDG 5 (Gender equality), the company "commits to continue making headway toward gender equality and leveraging the role of women in high executive positions".
Having run the rule over a selection of the ESG-linked logistics financings in the last two years, we can observe a basic trend: that the most commonly used KPIs are those that relate to property assets and decarbonisation of supply chains. While there are a variety of other ESG metrics that can apply to relevant businesses and operations, these appear to be deployed less often.
Although it is beyond the scope of this article to consider the measurement and assessment of ESG criteria, some confusion also exists in the lending market due to the myriad of platforms for benchmarking, assessing and certifying ESG factors and aligning with principles of green and sustainable lending more generally. Lenders and other investors may also have their own internal ESG frameworks.
Equally a lack of standardisation in both domestic and international markets complicates matters. Hand in hand with all of this of course are questions around ongoing borrower/occupier and investor governance, monitoring, and measurement. A recent rise in the number of transactions that utilise documentation and sustainability co-ordinators demonstrates evidence of the complexities involved.
It is perhaps no surprise therefore that the more established metrics around environmental impact and sustainability are those that currently dominate.
We note that the UK financial regulator the FCA is currently consulting on its proposal to introduce a package of measures aimed at clamping down on greenwashing. This includes sustainable investment labels, disclosure requirements and restrictions on the use of sustainability-related terms in product naming and marketing. See the shorter FCA press release in full.
We are aware that the various real estate sector industry bodies in the UK are collaborating with a joint response, which deals with some of the technical aspects regarding measurements and it will only be a matter of time before the market matures, which has to be a good thing for the market (and the planet).
BREEAM: the Building Research Establishment Environmental Assessment Method is a method (originally established in the UK but deployed worldwide) for assessing sustainability across the construction of a building and through its lifecycle. It involves assessment across a number of categories, including: energy efficiency and emissions; the health and wellbeing of building occupants and visitors; land use; materials; pollution; transport; waste; water consumption.
CRREM: the Carbon Risk Real Estate Monitor is an international standard that allows the science based measurement of decarbonisation efforts and also provides pathways for the real estate sector to meet the Paris Climate Agreement goals of limiting global temperature rises.
CSR: Corporate Social Responsibility is a business model that encourages companies to consider and address environmental, social and ethical issues in their supply chains.
EcoVadis: a provider of business sustainability ratings offering a system that allows organisations to evaluate their own and their supply chain's CSR levels. It encompasses 21 CSR 'indicators' across four main areas, Environment, Labour and Human Rights, Ethics and Sustainable Procurement.
The Greenhouse Gas Protocol: the world’s most widely-used greenhouse gas accounting standard. It uses 'scopes' as a way of grading and categorising the different kinds of emissions a company creates in its operations and beyond with its suppliers and customers.
GRESB: the Global ESG Benchmark for Real Assets is a framework that allows the ESG performance of individual assets and portfolios for real estate, real estate development, infrastructure funds, and assets to be measured. Based on self-reported data that feeds into relevant benchmarks, performance assessments are aligned with international sustainable development goals, the Paris Climate Agreement and international reporting frameworks.
HQE: Haute Qualité Environnementale is a green building standard in France, based on principles of sustainable development and controlled by the Paris-based Association pour la Haute Qualité Environnementale.
LEED: Leadership in Energy and Environmental Design is a green building certification and rating program run by the U.S. Green Building Council with the aim of improving performance across environmental and human health, energy efficiency, indoor environmental quality, materials selection, sustainable site development, and water use.
SDG: the 17 Sustainable Development Goals adopted by the United Nations in 2015, aiming to end poverty, protect the planet, and ensure that by 2030 all people enjoy peace and prosperity.
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