Green financing and green technology in rail

The story so far

The Paris Climate Agreement introduced in 2015 was the first universal, legally binding global climate change agreement. The UK ratified the Paris Agreement in 2016, agreeing to its aim to reduce gas emissions by at least 40 per cent by 2030, compared to 1990 emissions levels. Based on CO₂ emissions rates, rail is one of the greenest modes of transport available. It contributes less than 2.5 per cent of total transport emissions in the UK and about 0.6 per cent of the UK's total emissions. The rail industry will therefore be instrumental in delivering the climate change objectives set out in the Paris Climate Agreement.

But the rail industry cannot simply rest on its laurels. This is particularly the case given the significance of the climate change challenge and the pace of technological change. Major changes, on an industry-wide basis, are still needed.

Trains in the UK still rely predominantly on diesel traction for their power, and railway traction accounts for the greatest proportion of emissions within rail. An estimated 62 per cent of the rail network is currently diesel-powered.

In June 2019, the UK Government legislated to end its contribution to climate change by 2050: a target which requires the UK to become entirely carbon neutral less than thirty years from now. The Department for Transport has further challenged the rail industry to remove all diesel-only trains from the network by 2040. Transport Scotland has further thrown down the gauntlet, setting a more ambitious challenge to decarbonise domestic passenger rail services in Scotland by 2035.

How will the rail industry achieve these ambitious targets?

The Rail Industry Decarbonisation Taskforce reported that an estimated 3,000-3,300 diesel passenger vehicles will need to be replaced, re-engined or converted to achieve a carbon neutral railway.

The industry is already moving to modify existing rolling stock in order to reduce emissions. ROSCOs in particular are taking a proactive approach, not least to preserve the value of their rolling stock.

We explored some of the specific examples of new technological solutions being put into action by the industry in more depth in a previous article, in last month's issue of Rail Professional. Broadly speaking, the focus of the ROSCOs to date has been in modifying existing diesel fleets through retrofitting battery packs. There have also been examples of the use of hydrogen fuel cell technology in the industry. 

These new technologies provide huge potential for cleaner alternatives to diesel. The industry has already begun to invest in change. However, much of the technology is still in its relative infancy. For example, longer distance journeys on battery powered trains are not yet feasible. Hydrogen infrastructure is not widely available at depots and stations. Investment so far has therefore been piecemeal rather than widespread. It is also not clear that modification of existing fleets alone will be sufficient in achieving the challenging targets faced by the industry.

Electric powered trains are currently the only alternative to diesel that can run freight or passenger services with zero carbon emissions. But, with only roughly 38 per cent of all railway infrastructure in the UK currently electrified, further work (and investment) is needed in this area too.

The Commons' Transport Select Committee (TSC) recently reported that the government should publish a long-term strategy for not only the use of batteries and hydrogen technology, but also for the programme of electrification. A broad programme of electrification was underway until 2017. But this was scrapped by the then Transport Secretary Chris Grayling, due to delays and expanding budgets. As things stand, the electrification programme is set to recommence at the start of the next control period in 2024.

The TSC does not think this is soon enough. In its recent report, the TSC states that the government "must take the first steps and start the electrification programme as soon as possible rather than waiting for the start of the next control period in 2024". RIDT's report also called for additional, progressive electrification of more intensively used routes.

The general consensus is that the industry will only achieve the net zero carbon targets through a combination of electrification and the deployment of new technologies, such as battery and hydrogen power, in existing rolling stock.

Funding the change

Changes to rolling stock and changes to infrastructure will come at a cost. Battery and hydrogen technology continue to develop, but once there has been a landing on a suitable alternative to diesel, rail industry stakeholders will want to move quickly to implement the modifications. Electrification of infrastructure is particularly costly.

Traditional funding is of course an option, but as economies around the globe increase their emphasis on environmental issues, there has been a growth in emphasis on green finance. This emphasis has come from both the private and the public sectors.

The finance industry has been reacting for some time now and becoming increasingly proactive in the 'green' area. The UK government has also announced ambitious plans to position the UK at the forefront of green finance. As a result, green lending is set to increase and develop over the coming months and years. 

It's worth therefore considering what exactly green finance is and how it could potentially be relevant to the future changes for the rail industry.

What is green finance?

The term green finance covers a range of different financial products, offered in both the loan and the bond market.

A green loan is a finance product which requires a borrower to use the proceeds for a 'green' purpose. Although green loans have been around for a while now, in more recent years the Loan Market Association (LMA), in particular, has played a significant role in steering the market.

The LMA published a set of Green Loan Principles (GLPs) which define green loans as any type of loan instrument made available (in whole or in part) for new or existing eligible 'Green Projects'. The GLPs set out the framework for understanding the characteristics of a green loan, based around four key components:

• The use of the loan proceeds.
• The process for selecting and evaluating the project.
• Management of the loan proceeds.
• Reporting requirements.

The GLPs also set out an indicative list of the types of projects which constitute a 'Green Project'. The list includes "clean transportation – such as electric, hybrid, public, rail, non-motorised, multi-modal transportation, infrastructure for clean energy vehicles and reduction of harmful emissions".

This condition clearly has a direct relevance to the rail industry. Subject to meeting the requirements of the GLPs, if the proceeds of a loan are being used towards financing (or refinancing) a rail project, it's clear to see how that financing could be categorised as a green loan.

The GLPs build on the Green Bond Principles (GBPs) which were introduced first, back in 2014, by the International Capital Market Association. The GBPs are internationally recognised voluntary guidelines that promote transparency, disclosure and reporting in the green bond market. The GBPs similarly refer to clean transportation (and specifically rail) as an eligible 'Green Project' for the purposes of categorising a bond finance product as a Green Bond.

Green finance may provide financial benefits. Some (although not all) lenders on the market may only lend if there is a 'green' element to the funding. Others may offer a reduced cost given that the borrower is using the funds against certain green goals. Another key factor to consider is the increasing pressure which banks are coming under to consider climate-related and environmental risks in their governance and risk management frameworks (often referred to as 'ESG': Environmental, Social and Governance principles) and when formulating and implementing their business strategies. The Bank of England has also set up the Future of Finance Project, tasked with considering how financial services might evolve over the next decade. A key recommendation emanating from the project is to promote the smooth transition to a low carbon economy.

As a result, the amount of funding allocated by banks towards green projects and towards funding such green projects through green loans looks set to increase significantly over the coming years.

How has the rail industry used green finance to date?

The uptake of green finance in the rail industry has been more prevalent in continental Europe than in the UK. This can be explained in part by the current state of flux of the UK's franchising model, and also by Network Rail's ownership of the railway infrastructure.

However, given the scale of the challenge in meeting emissions targets set by the government, huge sums will need to be invested to transform or replace existing fleets. In addition, Network Rail has been calling for some time to transform the way in which third party private investors are able to fund, finance and deliver railway projects. As a result, it is likely that green finance will become more and more prevalent in the UK rail market.

In 2020, National Grid raised €500 million through a green bond in order to fund sustainability projects, citing that the proceeds could in part be used to finance clean transport infrastructure, such as electrification of railways. On the continent, Danish passenger operator DSB signed a €400 million green loan at the end of last year to finance the acquisition of 42 new electric locomotives set to be delivered through to 2025. Touax also recently carried out a refinancing of its railcar division, to the tune of €180 million, including a green loan.

A clear strategy from the UK government is still awaited on who, and how, the transition to a carbon-neutral and green rail industry will be funded. It is clear, however, that the use of green finance in the financing of new green technologies is only set to increase in the UK over the coming years.

This article was first published in the May 2021 issue of Rail Professional; it can be found here.