Green Heat Finance Taskforce: report part 1 - November 2023

6. Conclusions and Recommendations

6.1 Fostering Market Development

The Scottish Government has made a £1.8 billion capital commitment over this Parliamentary session (excludes future funding and financial commitments that may arise) to support decarbonising heat in Scotland’s buildings. This sits against an estimated total cost in excess of £33 billion to green Scotland’s buildings by 2045. As such, it is imperative that this public investment is used to effectively leverage as much private investment from alternative sources as possible. Private sector investment will need to play a crucial role in financing the transition to ZDEH and improving overall energy efficiency of buildings.

While this is a substantial sum, considering the scale of private sector institutional finance in the UK helps place it into context in terms of the overall size of a potential green financing market. For example, in 2021 a number of large UK pension funds, owning assets worth £870 billion, committed to cutting the emissions of their portfolios to Net Zero^[43]. These funds only account for a proportion of the UK pension fund market, which in turn is only part of the wider financial markets based in London. This suggests that the scale of potential private investment required to achieve Scotland’s Net Zero heating targets could be provided through existing financial markets. Unlocking that private investment potential and channelling it to support energy efficiency and ZDEH is, however, the challenge, and one this Taskforce has been exploring.

An important conclusion of this Taskforce is that, as a relatively new area in need of scaled investment, the financing market for energy efficiency and ZDEH has yet to meet its full potential. Challenges discussed earlier in this report explain some of reasons why the market is still in its infancy. However, coordinated and collaborative action across government, public and private sectors, can reduce these barriers and foster growth in a market which can unlock the scale of private investment required.

Our recommendations are, therefore, primarily focused on creating the conditions to foster and grow an effective finance market in Scotland for energy efficiency and ZDEH solutions, particularly for individual property owners. Doing so will enable investors to offer finance with confidence and for consumers to more easily access the financing they require.

6.2 Recommendations

In exploring possible financing solutions to tackle some of the specific barriers and gaps described earlier, the Taskforce has sought to understand the particular challenges and offer practical and deliverable solutions to address these.

Figure 6-1 below summarises our general approach to this work. It is worth noting that in reaching our conclusions, the Taskforce has sought to make recommendations that can either complement or supplement existing financing mechanisms, as well as provide novel approaches that ensure financing can overcome particularly difficult barriers. These may include supporting market growth of existing financing products that are relatively new, direct interventions that may overcome specific barriers, or potential solutions that would benefit from further development and demonstration. The aim of all these recommendations is to foster an environment that enables a range of products to be delivered at scale to finance energy efficiency and ZDEH measures, as there will need to be a mix of financial options overall to meet the varying circumstances of different individuals and businesses.

Figure 6-1 Summary of Taskforce recommendation process

• Sector specific understanding

  Market Overview

  Sector specific data, total buildings, EE and fuel type profile, demographics, applicable policies, etc.

• Financing available to building owners

  Current Financing & Support

  Overview of current products in market as well as SG support programmes

• Sector specific barriers and financing gaps

  Challenges and gaps

  Challenges and gaps Identify particular barriers, as well as gaps, where additional financing might support HiB Bill outcomes and scaling in medium to long-term

• Possible new solutions to address challenges

  Recommendations

  These may relate to supporting existing initiatives / market development, possible new products, research or market demonstrators to gather further evidence and evaluation of financing mechanism

Having considered the current structure of the built landscape in Scotland, reviewed current financing options, and explored the challenges constraining the growth of these products, the Taskforce is making nine recommendations for the Scottish Government to take forward in partnership with private sector organisations and other levels of government in relation to the areas discussed in this Part 1 Report. These are summarised in Figure 6-2 below, with our rationale for each recommendation set out below.

Figure 6-2 Summary of Taskforce recommendations

• Develop blended co-investment investment vehicles

  With support of the SNIB, SFE and SFT, identify where and how to best test a blended finance approach to finance ZDEH

• Work with Equity Release Council

  Develop an information framework and guidance for Green Retrofit Equity Release products

• Green lease / rental agreements

  Identify opportunities to pilot the use of green rental agreements to encourage retrofitting rented properties

• Map heat in building data gaps

  Establish a framework to promote open data sharing to address current gaps

• Co-ordination with UK Government

  Seek to influence UK Government and regulator policy to encourage installation of ZDEH solutions

• Expand current market engagement

  Work with GFI, SFE and other to expand engagement with brokers and quantity surveyors to promote and expand awareness of public for green financing products

• Non-Domestic Rates system

  Review how NDR can better support- and encourage ZDEH installations

• Review of available SG fiscal levers

  Explore the scope to use of LBTT or Council tax to incentivise ZDEH upgrade

• Research on Property Linked Financing in Scotland

  Work with GFI to explore potential to establish a scalable demonstrator of mechanism

It should be noted that much of the work needed does not necessarily relate to the creation of novel financing solutions, rather, for the Scottish Government, in partnership with others, to nurture a thriving market for green finance products. This will need to be underpinned by coordinated activity around key pillars like regulation, quality assurance standards, a well skilled and knowledge supply chain, and clear consumer protection measures. These wider features will need to be developed in parallel and will work in combination to stimulate demand for energy efficiency and ZDEH measures. That demand stimulation will, in turn, provide the confidence and delivery structures necessary to support scaling up of financing products.

6.3 Recommendations and How They Address the Identified Challenges

1. Recommendation

Scottish Government should encourage, from early 2024, increased market-customer engagement and communications – working with the Green Finance Institute, the finance sector though Scottish Financial Enterprise and other interested parties, to raise awareness of existing green finance products (particularly green mortgages and unsecured loans) with mortgage providers, distributors, brokers and quantity surveyors, and to further explore options for expanding the range of products available.

Taskforce Thinking

There are strong market drivers for financial institutions to grow green mortgage products arising from ESG requirements, potential mandatory reporting of EPC portfolios, as well as use of ‘green mortgage labels’ that may attract cheaper financing costs for banks. From a non-domestic perspective, there is a range of commercially available green finance products, although many businesses may be unaware of them, particularly amongst SMEs.

This recommendation looks to more fully raise awareness and understanding of green finance products amongst relevant professionals who form key relationships with homeowners, borrowers and businesses, and who can, therefore, support individuals and businesses in navigating the finance landscape for energy efficiency and ZDEH systems. It will also be important that lessons from smaller scale testing of green finance products are captured and used to inform subsequent product development. This includes where government action or messaging can help underpin a growing green finance market. Effective two-way channels of communication and engagement between government, customers and green finance professionals will therefore be required.

This recommendation will help address challenges discussed in section 4 of this report, specifically –

4.2.1 – Finance demand constraints and challenges; complexity of making the

right investment

4.2.5 – Finance demand constraints and challenges; lack of promotion of green

mortgage products

2. Recommendation

Scottish Government should begin work early in 2024 with the Equity Release Council to develop an information framework and guidance – alongside associated codes of conduct for expansion of these products by institutions – for the purpose of installing zero direct emission heating solutions, as well as the necessary building fabric improvements.

Taskforce Thinking

This recommendation will potentially unlock some of the equity lying in approximately 1.2 million homes for homeowners over 55 years old, who may have limited annual earnings, but value within their property. This may encourage greater involvement of the finance sector in developing and promoting green equity release products, of which there are currently very few.

There is market interest in developing new equity release products, including those which enable investment in measures to improve the environmental sustainability of homes. However, equity release is not a widely understood mechanism by the public at large and it is important that people considering equity release can get a clear understanding of any products they might be able to access. There are also some barriers which can limit private lenders’ willingness to offer equity release products to some properties, particularly if there are risks of negative equity or non-standard leaseholds. Clarifying which types of properties are suitable for equity release, coupled with consistently articulating the features of any products, will help build awareness of equity release as a viable financing option for some households.

To avoid all market participants developing their own guidance on equity release, and, thereby, making the overall landscape more complex and confusing for potential customers, this recommendation encourages the development of a coherent framework – drawing on existing industry best practice, such as the GFI’s Green Home Finance Principles and work of the Equity Release Council – which all parties can then work towards consistently.

This recommendation will help address challenges discussed in section 4 of this report, specifically –

4.2.1 – Finance demand constraints and challenges; complexity of making the

right investment

4.2.5 – Finance demand constraints and challenges; lack of promotion of green

mortgage products

3. Recommendation

Scottish Government should support the development of blended co-investment vehicles (blended financing) – with the support of the Scottish National Investment Bank, Scottish Financial Enterprise and Scottish Futures Trust. By the end of 2024 it should identify the most suitable focus and delivery structures that will help facilitate the joint deployment of public funding alongside private sector capital.

Taskforce Thinking

This recommendation supports reducing early market risk for a given aspect of infrastructure, either at an individual property, or at a communal based level. Co-investment vehicles may be particularly well suited for: facilitating larger scale investment; enabling public funding to readily ‘crowd-in’ private sector capital; and potentially providing a blended cost of finance that would be cheaper than otherwise available as it can pool resources, share expertise and spread risk between parties.

It can also create a scaled source of finance by ‘crowding-in’ private capital, which would otherwise not be offered at affordable levels by the private sector. This can be possible if public funding can be utilised to help de-risk the investment for other parties, for example, by taking a first loss capital role, or by blending public grant and/or commercial capital with private capital.

Whilst we see co-investment as having a role in the future heat in buildings finance mix, it is not a product that can be deployed in isolation, as it would need to be applied to a sector of the housing market and/or type of ZDEH measure technology deployment, most likely as part of a wider programme. The form of the co-investment vehicle, including its legal structure, would vary depending on the purpose of the fund.

This recommendation therefore encourages the Scottish Government to capitalise on the support and expertise of partners in Scotland (like the Scottish National Investment Bank) and at a UK level (like the UK Infrastructure Bank) as well as utilising insight from the private sector through SFE, to assess what blended finance vehicles are best suited to increasing demand for and support of ZDEH solutions and energy efficiency upgrades.

This recommendation will help address challenges discussed in section 4 of this report, specifically –

4.1.3 – Financing supply context and influences; green taxonomy

4.1.5 – Financing support context and influences; challenges constraining

financial sector provision of finance

4. Recommendation

Scottish Government should collaborate with the Green Finance Institute to research the viability of Property Linked Finance in Scotland, with a view to developing a scalable demonstrator of the mechanism by the end of the current Scottish Parliament in 2025.

Taskforce Thinking

This recommendation is about exploring the scope for financing to be linked to the property, rather than the property owner, within Scotland. This would result in repayment requirements transferring to a new owner when a property is sold. This means that whoever owns the property and benefits from the energy efficiency and/or ZDEH measures, is responsible for any repayments associated with their installation.

The PLF mechanism could help overcome a barrier, whereby people are reluctant to invest in measures with a long payback period if they are not certain they will be living in a property over a longer timeframe, and may not, therefore, realise the full benefit of the measures during the time they remain in the property.

While there is potential for PLF to form part of the overall financing mix for energy efficiency and ZDEH solutions, it is not currently available in Scotland. Further investigation is therefore required, in collaboration with the GFI which is actively developing this solution for the UK market, to identify where and how it might be applied in Scotland, as well as what supporting structures would need to be in place to foster the development of a PLF market.

This recommendation will help address challenges discussed in section 4 of this report, specifically –

4.1.5 – Financing support context and influences; challenges constraining

financial sector provision of finance

4.2.2 – Finance demand constraints and challenges; perceived impact on property

value

4.2.6 – Finance demand constraints and challenges; legislative barriers

5. Recommendation

Scottish Government should review and publish, by the end of 2024, the scope to utilise fiscal levers and taxation policy in Scotland to facilitate and accelerate the installation of zero direct emission heating solutions and energy efficiency measures.

Taskforce Thinking

While we recognise that the Scottish Government does not have full control over fiscal levers, it does have control over a range of taxation measures, including Land and Buildings Transactions Tax (LBTT) and Council Tax, which offer the potential to influence home owner and purchaser decisions around investing in energy efficiency and ZDEH solutions. Using these levers is one potential route to increasing demand levels for retrofitting properties.

This recommendation recognises that taxation levers have been used in some other countries to incentivise private retrofitting investment. It also highlights that there is merit in further exploring the degree to which fiscal measures could be used in Scotland, which levers could be most effective, and how they might be deployed in practice. This is in line with the Scottish Government’s 2021 Heat in Buildings Strategy, which committed to considering how local tax powers like Council Tax could be used to incentivise and encourage retrofitting of buildings.

This recommendation will help address challenges discussed in section 4 of this report, specifically –

4.2.2 – Finance demand constraints and challenges; perceived impact on property

value

4.2.3 – Finance demand constraints and challenges; poor financial returns

4.2.6 – Finance demand constraints and challenges; legislative barriers

6. Recommendation

Scottish Government should review and publish an analysis, by the end of 2024, of how non-domestic rates reliefs can better support and encourage investment in energy efficiency and zero direct emissions heating.

Taskforce Thinking

This recommendation aims to overcome currently competing impacts, whereby private investment by non-domestic building owners in energy efficiency and ZDEH measures can create a green rental premium by, on the one hand, helping tenants lower energy bills through using less energy than would otherwise be the case, whilst simultaneously increasing the rateable value of the property.

This can mean that energy cost savings are offset by rateable bill increases, and result in making the property less commercially attractive than alternatives that have not been retrofitted.

This is a practical recommendation related to a devolved tax power and which, if addressed, offers the potential to remove a barrier currently acting as a disincentive to retrofitting across the non-domestic sector. This recommendation is also aligned with a commitment in the Scottish Government’s Heat in Buildings Strategy (2021) which agreed to consider how powers like non-domestic rates could be used to encourage the retrofit of buildings.

This recommendation will help address challenges discussed in section 4 of this report, specifically –

4.1.1 – Financing support context and influences; overarching macroeconomic

drivers

4.2.6 – Finance demand constraints and challenges; legislative barriers

7. Recommendation

Scottish Government should commission research, by mid-2024, to help mitigate the split incentive issue by exploring options for the use of green rental agreements in Scotland, and then pilot deliverable approaches, by early 2025, to encourage retrofitting in privately rented properties.

Taskforce Thinking

This recommendation aims to help overcome the split incentive barrier, between landlords incurring the capital and financing costs of installing ZDEH technologies and energy efficiency measures, and tenants who receive the associated benefit, whether or not they are using energy more efficiently.

Green rental agreements and leases can apply across both domestic and non-domestic sectors, and guidance on good practice does exist. However, the application of such agreements or clauses has not been widely demonstrated. The Taskforce believes it would be beneficial to test such agreements in practice, building on the work of the Better Buildings Partnership and GFI on green leases and green rental agreements respectively, to build real life evidence and experience on where and how they can most effectively be utilised. Disseminating the outputs of any pilot initiatives would, in turn, help plan for a wider rollout of such agreements and clauses as standard in all leases over time.

This recommendation will help address challenges discussed in section 4 of this report, specifically –

4.1.1 – Financing support context and influences; overarching macroeconomic

drivers

4.2.4 – Finance demand constraints and challenges; split incentives

4.2.6 – Finance demand constraints and challenges; legislative barriers

8. Recommendation

Scottish Government should immediately seek to engage with UK Government and regulators to ensure alignment of approaches and support coordination of activity between governments and regulatory bodies.

Taskforce Thinking

This recommendation aims to foster consistency and alignment of policies around energy efficiency and ZDEH across Scottish and UK Governments, particularly with regards to implications for financing the transition. Many larger companies, which will play an essential role in transitioning to zero emissions heating, operate across the UK, for example, energy or finance providers. Having a consistency of approach and policy goals will, therefore, make it easier for these companies to develop and deliver financial products and other services associated with improving energy efficiency and installing ZDEH systems.

Additionally, there is a range of potential levers currently reserved to the UK Government, including key aspects of fiscal policy and the treatment of VAT with regards retrofitting works. The Taskforce believes it would be beneficial for governments to work together, and with industry and consumers, to explore collectively how to most effectively stimulate demand for energy efficiency and ZDEH measures.

While engagement between the Scottish and UK Governments will be important in creating this consistent structure for the market, it will also be important to develop and maintain productive relations with UK regulators. This includes both OFGEM, the energy regulator, and the FCA, which regulates the provision of financial services. OFGEM has a critical role to play in helping reduce the differential in gas and electricity prices, so as to help improve the attractiveness of converting to electric heat systems, as well as a range of factors influencing the retail electricity market supply and demand balance. The FCA establishes the rules that finance providers must adhere to in areas like the proportion of asset books that must comprise green investments, or the level of capital that must be held against loan books. Changes in these regulatory parameters could have a big impact on incentivising private capital provision for retrofitting activities, and it would, therefore, make sense to explore these collaboratively.

This recommendation will help address challenges discussed in section 4 of this report, specifically –

4.1.1 – Financing support context and influences; overarching macroeconomic

drivers

4.1.3 – Financing supply context and influences; green taxonomy

4.1.4 – Financing support context and influences; other influences from

government and other markets

9. Recommendation

Scottish Government should map, by mid-2024, the current availability of physical and investment-related data pertinent to heat in buildings – identify gaps and establish a framework promoting open data sharing to address these.

Taskforce Thinking

This recommendation aims to support the ongoing monitoring and evaluation of how Scotland’s buildings are progressing towards ZDEH targets. While there is a wealth of data available, and private finance providers will develop their own databases as they start testing products like green mortgages in the marketplace, this does not always provide a complete picture of the current situation. For example, robust data on the energy efficiency and heat use in the non-domestic sector can be difficult to track, as some businesses generate significant amounts of heat from processes undertaken, rather than to maintain temperatures in spaces, while others use a single fuel source for multiple purposes, making it difficult to identify the proportion used for heat.

Reliable and consistent data on the current state of the energy efficiency performance and level of ZDEH systems installed across different types of domestic and non-domestic properties is important for overall retrofitting policy, as well as enabling finance providers to effectively develop and target financial products at different customers. Markets function best where full information is available to all parties, as this enables customers to make better informed decisions, while providers can accurately reflect risks in deciding upon prices. For a nascent, yet growing, market such as finance for energy efficiency and ZDEH, the principle of open data will also be beneficial because it will help ensure that all parties can access all relevant information to inform their decisions^[44]. It will also be beneficial in terms of developing an improved evidence base to support policy implementation.

This recommendation will help address challenges discussed in section 4 of this report, specifically –

4.2.3 – Finance demand constraints and challenges; poor financial returns

4.2.7 – Finance demand constraints and challenges; quality of data