Financing Sri Lanka’s Sustainable Built Environment: Pathways for Collaboration

This article first appeared in the newsletter of the Green Building Council of Sri Lanka published in December 2020 (Page 21 to 25 of The Green Guardian)

https://srilankagbc.org/sustainability-as-the-new-normal-combating-the-pandemic-through-sustainability/

With the onset of the Covid 19 pandemic, economies world over have been disrupted and Sri Lanka, with a large debt overhang, is in an unenviable position with limited fiscal space to stabilize its economy.

The European Commission, in December 2019, had presented a Green New Deal, aiming to transform EU economy to achieve carbon neutral status by 2050. Amidst Covid 19 pandemic, the EU had maintained its resolve towards this goal and dedicated Euro 550 billion for a green recovery plan that includes a renovation wave strategy to improve the energy performance of buildings and expand the market for sustainable construction products and services.

In comparison, due to budget constraints, Sri Lanka’s government support to building and construction sector has been lagging, with LKR 242 billion owed to contractors on civil works of public infrastructure being released post 2020 general election after much delay. In October 2020, to further support the sector, the Govt. announced a policy decision to favor local contractors for construction and for sourcing of materials. With the 2021 budget, Govt. had unveiled slew of tax concessions for housing and construction including for housing loans, REITs, and notably 10 year tax holiday for investments in recycling and reuse of construction material, which is an important measure with respect to sustainability of the construction industry.

Even though Sri Lanka has not set explicit targets on a green recovery, Sri Lanka’s National Physical Plan till 2050 published in 2019 and incumbent President Gotabaya Rajapakse’s vision and strategy statement “Vistas of Splendour and Prosperity” outline infrastructure and housing improvements that possess sustainability elements, which could form a part of a green recovery strategy for Sri Lanka.

However, with debt service obligations on average of USD4.3 billion each year from 2021 to 2025, Sri Lankan government would be constrained in allocating 4% of GDP each year for capital expenditures as in the past, as it has to prioritize debt repayments. In having to balance the geopolitical interests of foreign partners who could assist Sri Lanka in managing this debt situation, Sri Lanka has also had to review its long-term infrastructure projects, opting to favor short term fixes over long-term solutions (eg: multi-story car parks fast-tracked whilst halting light rail transit project).

With the tightening of rental incomes because of demand contraction owing to drop in tourism, corporate downsizing and working from home, and fall in retail customer footfall, private sector investment in real estate and construction could also be sluggish in the short term and spurring of growth in the sector would be contingent on government support programmes.

Given this context of government and private sector being constrained with access to capital, how could Sri Lanka finance the development of its sustainable built environment? This article follows a presentation on the same topic delivered by the author at a webinar organized by Green Building Council of Sri Lanka in August 2020.

While the innovative financial tools that were presented during that webinar will be briefly recapped towards the end of this article, the author will focus this write-up on few new recommendations vis a vis policy and collaborative implementation mechanisms needed to ensure new investments in buildings and infrastructure are directed towards sustainable built environment.

Collaborative Models to Mobilize Sustainable Finance for Built Environment

Given the constraints with public finance, Government will need to induce private investment towards infrastructure and built environment. Going beyond the usual modus operandi of public private partnerships based on long term land leases, the Government is also attempting to access the capital markets by setting up an investment firm in the form of Selendiva Investments. Such new approaches to unlock private investment must be commended. However, as infrastructure and buildings carry long term implications on quality of life with both short and long term impacts on the environment, it is imperative that sustainability standards are integrated to these private investments, so that not only the financial metrics but also the economic, social and environmental aspects are assessed and considered in the investment decisions.

Sustainable Finance Taxonomy

To this end, the Government through its State Ministry on Money and Capital Market and State Enterprise Reform could play a proactive role in supporting the Inter-regulatory Committee on Sustainable Finance led by the Central Bank of Sri Lanka, which is currently working to introduce a sustainable finance taxonomy for Sri Lanka to mainstream sustainable investment products to the market. Such a taxonomy will give guidance to financial institutions in the capital and money market (including banks and finance companies) to introduce new financial products, such as Green Construction Loans, Green Bonds, Green REITs and Green Mortgages that could support investors, building developers and home buyers to adopt green building options. It is vital that stakeholders in the real estate, buildings and constructions industry remain engaged in this process, so that the appropriate criteria can be set for Sri Lanka with respect to investments in sustainable built environment. Green Building Council of Sri Lanka could play a defining role in such stakeholder consultations and in recommending criteria/thresholds to be set for the sector to the experts involved in drawing up the sustainable finance taxonomy.

Building Material Traceability and ESRM

With illegal sand mining, logging, stone quarrying  and other environmentally damaging sourcing practices of building materials being a concern in Sri Lanka, a certification/ traceability scheme that provide transparency of the supply chain could be part of the solution in highlighting those building material suppliers who are sourcing the materials responsibly.

Currently, financial institutions in Sri Lanka conduct environmental and social due diligence when they lend, especially for construction activity, where there could be significant environmental and social impacts. This environmental and social risk management (ESRM) framework of financial institutions could be used as a lever to influence project developers to source building material from suppliers who comply with a responsible sourcing certification/traceability scheme. With 5.6mn square meters of built space yet to be constructed in Colombo Port City alone, such a certification system could serve to ensure that the building material suppliers do not damage critical ecosystems in fulfilling such demand.

Such a responsible sourcing certification scheme could be developed through the collaboration of multiple parties including Geological Survey and Mines Bureau, Green Building Council of Sri Lanka, and  Sri Lanka Banks’ Association’s Sustainable Banking Initiative with possible support from the UNDP Biofin Initiative.

Spatial Planning, Spatial Finance and ESRM

Land use planning is also crucial to managing climate change (both mitigation – through for example, countering deforestation; and adaptation - through vulnerability analysis and avoiding settlements in land slide or inundation prone areas) and managing biodiversity loss. The National Physical Plan that has been developed further to detailed studies carried out on regional strategic environmental assessments and master plans, forms the basis for effective zoning and building code regulation. It is further complemented by the National Spatial Data Infrastructure (NSDI) platform, on which the relevant spatial data in relation to urban and regional planning is made available.

However, in order for these larger national frameworks to translate into desired results at the ground level, enforcement is key (as the lapses like the collapse of a building in Kandy had recently shown with regards to building code regulation). With many property developers seeking loans from banks and finance companies, the environmental and social risk management framework of financial institutions could be used as a second line of defense to complement enforcement efforts of local authorities in deterring violations of zoning and building code regulation.

In the UK, the environmental and social risk management by the financial sector is gaining new capability with the development of spatial finance, where advances in remote sensing, artificial intelligence, cloud computing and data science is allowing financial institutions to analyze and forecast value at risk, in addition to helping them to monitor the compliance and impacts of their investments.

Similar spatial finance capability could also be developed in Sri Lanka through a partnership between the UDA, NBRO, ICTA, and Sri Lanka Banks’ Association’s Sustainable Banking Initiative, where banks and finance companies could make their clients aware of risks (e.g.: landslide, flooding, sea level rise, elephant migration pathways, etc.) and inform them on decisions relating to siting and design of buildings and constructions in using an online GIS tool like Google Earth.

Collaborative Innovation for Community Empowerment via 4IR Tech and Models

With vertical living or gated community living gaining increased traction, there is a need for investments in community infrastructure and community spaces. Technologies such as Internet of Things (IoT) and new economic models such as shared economy or circular economy models allow for innovative solutions like community level renewable energy microgrids, community farms using precision agriculture and rainwater harvesting, etc. However, for such advancements to take place in Sri Lanka, collaborative innovation is needed on the part of developers, utilities, service providers, and financiers. In this context, the partnerships like the MoU between LECO, University of Moratuwa, ADB, DIMO and DHYBRID to pilot a microgrid implementation in Sri Lanka is encouraging. Green Building Council of Sri Lanka, Condominium Developers’ Association of Sri Lanka and Sri Lanka Banks’ Association’s Sustainable Banking Initiative could collaborate to develop new financial products to finance such community infrastructure.

Financing Instruments or Tools

Debt for Nature Swaps

This is a financing option for the Government, where it could request its debt holders (like ADB and World Bank Group) to forgive a portion of its debt or forgo debt service payment in return for investments in Nature Based Solutions and Climate Action. Some of the following investments outlined in President Gotabaya Rajapaksa’s five year plan could qualify for such consideration: urban forests, water gardens and wetlands, green belts along highways, park and ride systems (for transport emission reductions), waste management and recycling and natural storm water retention.

Results Based Financing/ Pay for Success

Another strategy for Government and private sector to undertake infrastructure investment, without necessarily having to make the funds available at the beginning is the pay for success financing model. Some countries (national govts and municipalities) have used impact bonds (where payout at maturity is commensurate with achieving of the desired social and/or environmental outcomes). For example, some countries that were experiencing flooding in cities or tidal waves/coastal erosion have attracted private organizations to invest in green infrastructure like sponge cities and mangrove or coral ecosystems, where the private organizations are repaid with a premium if they had managed to achieve disaster risk reduction parameters.

Private sector companies and financial institutions in some other countries are also exploring Sustainability Linked Loans, which is also a form of pay for success model, where if a private company that sets ambitious sustainability targets such as reduction in energy intensity, water intensity or volume of waste achieves the said target, the financial institution will award an interest subsidy as a positive reinforcement.

Green Real Estate Investment Trusts (REITs)

Securities and Exchange Commission (SEC) together with Colombo Stock Exchange earlier this year, launched the framework for Real Estate Investment Trusts (REITS). Like Unit Trusts, REITs pool capital and allows for retail investors to participate in the capital market even with small investments. The underlying asset in the case of REITs is some sort of income generating real estate asset. Developers of such property who wish to move on to other investment opportunities could unlock some of the tied-up capital by listing these properties with REITs. It would serve Sri Lanka well if we could transition the REIT framework to Green REIT proposition, where a considerable proportion of net leasable area or revenue from the Trusts’ portfolio stem from building stock assessed as Green Buildings or Green Infrastructure. That way the developers are incentivized to integrate sustainability aspects from project conceptualization and design, understanding the market signals.

Green, Blue, Social, and Sustainability Bonds

Large share of Govt. debt maturing within next 3 years is commercial rate international sovereign bonds. Govt. attempts to refinance by reissuance of bonds has run into difficulty with some Issues being under-subscribed and investors demanding high return given the challenging debt profile of the Government. However, if the Government is able to structure Green Bonds, where the proceeds will be used for green infrastructure and green investments (or blue bonds for investments in the Ocean/Marine related sustainable infrastructure or social bonds and sustainability bonds relating to SDGs) meeting the ICMA or Climate Bonds Initiative standards, then the Govt. would be in a position to attract many global investors who are actively seeking such investment opportunities. IFC and other Development Financial Institutions have in the past assisted countries to issue local currency green bonds, including through private placements and listings in international markets like London Stock Exchange, providing certain guarantees and assurances to international investors. Countries such as Fiji and Seychelles have successfully raised financing through such green and blue bonds.

Beyond sovereign bonds, there is also room for municipalities and corporates to also access sustainable investment flows in structuring green or sustainability bonds. While accessing international climate and sustainable finance flows could be favourable in comparison to other commercial debt from international investors, it is important that Colombo Stock Exchange also develops capability to list Green, Blue, Social, Impact, Sustainability Bonds to raise domestic finance for sustainable infrastructure.

Green Mortgages

In countries such as Romania and Costa Rica, the Green Building Councils of these countries, the banks and developers had collaborated to bring green mortgage proposition to market, where home buyers could afford slightly expensive properties which had integrated green building standards, as a result of banks willing to provide credit enhancements (giving a higher loan amount) or by reducing the rate for monthly installments, since green buildings are expected to perform better than other buildings in terms of energy, water, refrigerant and other resource consumption and save money for the owner, which adds to the loan repayment capacity of the homebuyer. In some markets, green buildings also have a higher resale value, so there is a higher value for the collateral for the bank. A feasibility study to introduce Green Mortgage proposition in Sri Lanka is being spearheaded by UNEP – FI in Sri Lanka with the support of the National Cleaner Production Sector. International Finance Corporation (IFC) of the World Bank Group is also building awareness of the local financial sector on its EDGE certification, which provides set of tools for financial institutions to assess the sustainability of building/infrastructure investment proposals put forth by clients. Sri Lanka Banks’ Association’s Sustainable Banking Initiative is playing an active role in partnership with UNEP FI and IFC.

Property Assessed Clean Energy (PACE) Programs

Gaining momentum in countries like the US, PACE programs also serve to increase green building stock. However, unlike Green Mortgages, where the funds borrowed are tied to the home buyer, in PACE programs, the loans are tied to the property and is recovered by the local government authority through assessment rates/local government taxes.

Some home buyers do not want to hold on to a property for too long and since the net benefit of green building investment could take few years to realize, they may not have the incentive to make that extra investment for a green building. This disincentive is tackled by the PACE program, where the municipality offers the developer or home builder a loan through a third party (financial institution) at the stage of construction and the obligation to pay for the property pass on from one home owner to the other, as the loan is recovered through the assessment rates/taxes on the home property. Sri Lankan local government authorities could also devise such a framework to incentivize green building constructions within their administrative areas. 

Energy Attribute Certifications/Renewable Energy Certificates

There are many corporates that are adopting targets to achieve a higher proportion of their electricity consumption to come from renewable sources. However, given the limitations of physical premises (such as lack of roof space for solar PV installations, enclosed spaces with less wind and solar potential), it might not be feasible for these organizations to generate renewable energy to match the levels of their consumption. This has created a demand for renewable energy certificates, where the responsible corporate are willing to pay a fee to incentivize renewable energy developments elsewhere that would allow them to offset the negative impacts of their consumption. Such renewable energy certification schemes could be an additional source of income to renewable energy developers that could increase the financial feasibility of such investments. Sustainable Energy Authority could play a pivotal role in bringing such a proposition to the market.

Green Leases

Green leases are another mean of financing sustainable building improvements. Either the owner or tenant in a commercial lease could undertake the investment to make a building improvement on sustainability and their investment could be recovered/set off either through utility payments/rent payments.

Above are only select examples of collaborative pathways and arrangements, where different actors like the Green Building Council, building/infrastructure developers, home owners/corporates, banks and financial institutions and government authorities could work together to support the transition towards a more sustainable built environment. Such innovations cannot occur in isolation but need all parties to contribute towards this objective. Signs are afoot that there is greater convergence in the strategies of these actors towards sustainable buildings and infrastructure. Onus is upon us to fast track this transition in playing a catalytic role in our respective professions and in our lifestyle decisions.