In April 2023, David Geale of the Financial Conduct Authority (FCA) delivered a speech emphasising the importance of green mortgages to lenders’ transition plans and examined the opportunities and risks that these products present.
Many lenders are now obligated by FCA rules to report on their organisation’s carbon emissions to the Task Force on Climate-Related Financial Disclosures’ (TCFD) standards. Additionally, FCA is consulting on expanding these requirements to require firms to produce transition plans which accord with the Transition Plan Taskforce’s Disclosure Framework.
For mortgage lenders, balancing the need to set ambitious targets with what is achievable can be a challenge, because they have relatively little control over the asset which emits the most carbon – their mortgage portfolio.
Green mortgage products can incentivise customers to reduce carbon emissions from their homes whilst empowering customers to achieve their own climate ambitions.
For lenders this is an opportunity to enhance their brand and reputation as well as attract green investment. This route can also help future proof portfolios against the risks climate change will present over coming decades.
However, there are key risk factors for lenders to take into account which can include greenwashing accusations, breaches of consumer duty and the inadvertent creation of mortgage prisoners.
Accuracy of disclosures
The typical green mortgage rewards customers for meeting a defined sustainability goal, such as buying a property with a higher EPC rating or making green home improvements. By tracking the right data, lenders can quantify resulting carbon reductions and demonstrate they are achieving sustainability goals.
Ensuring this data is meaningful and reliable is key if lenders are to avoid the risk of greenwashing, which could trigger regulatory action, disputes and adverse publicity.
Regulatory risk could arise in this context from inaccurate TCFD disclosures or a breach of the FCA’s forthcoming anti-greenwashing rule. Lenders who rely on sustainable funding lines to fund green lending could also find themselves in dispute with funders if inaccurate data impacts their ability to meet agreed sustainability objectives.
Firms’ data on sustainability metrics such as carbon emissions clearly needs to be sufficiently granular and accurate, but there are other factors which can impact upon data reliability.
Where a green mortgage requires a certain EPC rating, the accuracy of the EPC assessment is critical. If lending is provided to achieve specific sustainability goals, the funds need to be applied by the customer for the intended purposes in order for the benefit of those goals to be realised.
Ensuring good customer outcomes
Lenders will need to carefully consider their customer base and target market when designing green mortgages, as part of their consumer duty product assessments, in order to understand customers’ needs and ensure good outcomes.
From a customer understanding perspective, lenders will want to ensure that the product’s sustainability targets can be clearly understood by the target consumer.
For example, will the customer be able to understand the action required of them to achieve a cheaper rate? Do they appreciate the consequences if sustainability criteria are not met?
Promotional materials and product literature should not over-state the product’s green credentials, which the FCA say would breach the cross-cutting rule on acting in good faith and could also breach the forthcoming anti-greenwashing rule.
One very relevant factor is the type of properties their target market live in – what are the typical EPC ratings and, for lower rated properties, how feasible/expensive is retrofitting? Are there specific challenges for customers with listed buildings? The customers’ characteristics will also be important including their personal sustainability goals, their ability to afford those goals and their level of understanding.
An ancillary risk to consider is the unintended impact that sustainability linked incentives might have on some customers and the wider property market.
Incentives linked solely to EPC ratings could skew property values in favour of properties with higher ratings, without the right products also being made available to empower customers with lower rated properties to improve their energy efficiency.
Careful attention also needs to be paid to customers who cannot afford to improve the efficiency of their homes – if the right products are not made available to them they could form a new category of mortgage prisoners. A delicate balance needs to be struck.
Third parties in a lenders’ supply chain could also impact on customer outcomes. These parties could include EPC providers or partners engaged to carry out retrofitting works.
Lenders need to consider who falls within their supply chain and where interactions with those parties might generate foreseeable harm. Once a product is live, lenders should ensure appropriate auditing of their supplier chain is carried out to monitor customer outcomes.
Eyes on 2050
Mortgage lenders can play a key role in helping society achieve net-zero but, as with all aspects of the transition, careful and detailed planning is required both to manage risk and ensure good customer outcomes.
