Money talks. So do ambitious energy efficiency goals

In 'Whoops!', his brilliant, compulsively readable book about the financial crisis, John Lanchester describes the gulf between the finance and policy worlds. They are often on different planets, speaking different languages. That is nowhere more true than in the current negotiations on the EU's energy efficiency goals.

Too many policymakers still talk of higher targets as a cost and a burden, and worry about going too far. Investors, however, see things very differently. For them ambitious, binding legislation means lower risks, more attractive markets, and higher returns. And for their customers – building and homeowners – it means lower financing costs, lower energy bills, and higher property values.

Note: This column is published at the same time as a new eceee briefing on energy efficiency financing.

It comes down to this: resolute political support for energy efficiency buys that priceless commodity, confidence.

How does energy efficiency financing work?

Banks lend trillions of euros every year to homeowners and businesses. Typically, the bank will hold on to a loan for a couple of years - making money on the interest in the process - then group loans together and sell them on to institutional investors like pension funds. The bank receives an agent’s fee when arranging the loan with the homeowners, and another fee from the pension fund.

Put simply, the bank is the middleman in a win-win system. At one end of the spectrum, homeowners and businesses get the capital they need for their projects. At the other, pension funds purchase a long term source of revenue (the 5, 10, 15 or 20 years’ duration of the repayments on the loans).

Energy efficiency improvements are often a by-product of this process, but it's in everybody's interest to make them specific and systematic. Green mortgages - that is, loans to fund the purchase of a property and make it more energy efficient - lead to lower energy bills and higher property values. This lowers the risk for the bank, because there is less chance of the homeowner or business defaulting on the loan, and even if they do, the value of the property is higher. As a result, the bank can offer their customers lower interest rates.

At the same time, it becomes easier for the bank to sell on the loans to pension funds and other big investors. Why? Pension funds have a fiduciary duty to their pension holders - in essence, they must not lose their money. Therefore the safer the loans, the easier it is for the pension fund to justify the purchase to its financial regulators. If the pension fund cannot justify the investment, it will place its capital in other areas, or in other countries.

What is the impact of ambitious, binding energy efficiency legislation?

First, it drives forward energy saving. Just taking the EU 2030 efficiency target from 27% up to 30% stimulates savings equivalent to the annual energy use of Belgium. The 40% target recommended by the European Parliament (and my company) translates into millions of extra buildings renovated and thousands of businesses becoming more efficient.

What's more, since the financial crisis (triggered by banks contracting un-repayable loans, then selling them on to other banks and investors) banks are reluctant to create demand for their products. Instead, they want to react to the demand created by EU and national legislation.

Second, binding legislation reduces risk and gives a long-term vision and perspective. Take the case of ING in the Netherlands. The bank's property estate division has loans on roughly 30,000 commercial buildings. At present, only about 20% of these buildings are in the A-C energy efficiency category. However, ING recently commissioned analysis showing that the more efficient buildings were worth on average 10% more, and generated about 10% more rental income. In short, these buildings were better and safer investments.

ING was therefore well-placed when the Dutch government passed legislation saying that commercial buildings cannot be leased after 2023 unless they are in the A-C efficiency category (and no less than A class after 2030). Because the bank understands that efficient buildings are lower risk, it is able to offer its clients 100% financing at lower-than-average interest rates to bring its entire building portfolio - 30,000 commercial buildings - up to A-C standard.

Third, binding legislation means more business for investors. For a high risk investment, banks and pension funds have to hold back high reserves of capital (it's one of the safeguards built into the financial system in the wake of the crisis). But regulators don't require as much capital to be held in reserve for safer investments. This means the bank or investment fund can put to active use a higher share of its capital, and therefore make more money, which is its raison d'être.

The key point is that risk carries a cost, and that binding energy efficiency legislation reduces that risk.

So are investors calling for ambitious legislation? Yes, very much so. The Institutional Investors Group on Climate Change (IIGCC) is a group of over 130 pension funds representing 18 trillion euros (that's six times Germany's GDP) is calling for a binding EU-wide energy efficiency target of at least 30% by 2030 and an annual energy savings target of more than 1.5%. Game-changing investments - and the socio-economic and environmental benefits that go with them - are available provided policymakers make the first move and set higher goals. Money talks, we all know that. So does ambitious, binding energy efficiency legislation.

Note: This column is published at the same time as a new eceee briefing on energy efficiency financing.

The views expressed in this column are those of the columnist and do not necessarily reflect the views of eceee or any of its members.