Carole Steimlé, partner (Paris) and Nav Sahota, partner (London) at Reed Smith
Environmental, Social and Governance (ESG) policies are designed to encourage businesses and organisations to think about their impact on their sectors, communities, and the wider world. ESG has become a vital business consideration, and represents a challenge, but also an opportunity, for the real estate sector.
Real estate investors are currently largely focused on the ‘E’ pillar – seeking environmentally-friendly targets such as positive energy and zero carbon assets. However, awareness is also growing that real estate can have a social impact on the health and wellbeing of staff (a consideration which has gained importance due to the pandemic), as well as the local community. Governance is perhaps the strand which needs most work, with the issue of diversity in the professions supporting real estate particularly in need of addressing.
While it has become commonplace to make sweeping claims about ESG credentials, with companies under increasing scrutiny for greenwashing, it is interesting to explore how much progress has actually been made by the sector, and to weigh up existing, as well as upcoming, rules and regulations in both UK and EU law that may affect the development of ESG.
What is the overarching legal background in the UK and the EU?
In 2019, the UK set itself a statutory net zero carbon target for 2050 under the Climate Change Act 2008. Real estate contributes 30% of global greenhouse gas emissions – on a par with the transportation and energy sectors in terms of environmental impact – so has a key role to play in the net zero target. More recently, the Treasury have set out plans to green the financial system in ‘Greening Finance: A Roadmap to Sustainable Investing’.
New Sustainability Disclosure Requirements will require companies, some financial institutions, and occupational pension schemes, to disclose sustainability-related information. There are three types of disclosure: corporate disclosure; asset manager and asset owner disclosure; and investment product-level disclosure. Real estate asset managers will therefore fall within the scope of these requirements.
By comparison, the EU’s requirements have been set out as part of the EU Action Plan on Sustainable Finance. This plan introduced The EU Sustainable Finance Disclosure Regulation (SFDR), which requires those in the financial markets to disclose the sustainability data of their investments.
The second key piece of regulation is the Taxonomy Regulation, which came into effect on January 1st, 2022. This is part of the EU’s own drive to achieve net zero by 2050 and provides uniform criteria so companies and investors can establish whether something is ‘environmentally sustainable’. Together, these changes place ESG at the forefront of investors’ minds.
How are legal constraints driving progress in the real estate world?
Legal constraints have acted as a catalyst for a shift in the way the sector views ESG. In France, for example, a number of laws introduced aim to improve businesses’ ESG impact, including:
- Prohibitions on leasing non energy efficient flats (in the residential sector)
- Obligations to reduce the building consumptions for logistic, retail, offices, with clear targets and sanctions
- Net zero artificial land target
- Construction efficiency targets
Similarly, the UK has brought in legislation that aims to improve the impact of real estate. The Minimum Energy Efficiency Standards (MEES) for commercial properties, which currently applies to new leases or renewals, will be expanded to apply to all privately rented property. From April 2023, it will be a breach for landlords to continue to let commercial premises that are sub-standard. In the construction industry, building regulations have been getting more stringent requiring far higher greener standards – a trend set to continue.
So how can investors improve their ESG impact?
Social and governance areas are lagging behind, with diversity a continuing issue for real estate. In France, a white paper authored by a women’s real estate network suggesting a charter in favour of equality is due to be adopted by significant organisations. Similarly, large real estate businesses are calling on contractors or tenants to improve local, diverse employment.
Crucially, company leadership should be drawn from a diverse candidate pool to encourage progress from the top down – focusing now on improving existing social and governance obligations will pay dividends as ESG becomes normalised across the industry.
How can progress be made?
Putting ESG into practice: ESG still remains, in the eyes of some, an unapplicable buzzword. Knowledge and understanding of requirements is improving, but businesses remain unclear on how to apply these to their own operations. Education should be at the forefront of embedding ESG into real estate.
A holistic approach: Investors, developers and occupiers are not always in full command of the use of their assets. It is important to build ESG considerations into contracts, making them an integral part from the get-go.
Initial costs: Unfortunately, sustainable assets come with a substantial price tag – whether that is buying, building, or refurbishing. However, a global consensus that ESG is important may cause investors to conclude that short-term costs are less burdensome than the prospect of fines and compliance costs later down the line, as well as, crucially, the impact on valuations and marketability.
Real estate is a sector that is contingent on the built environment. To be smarter, better, and more sustainable in building practice is surely, therefore, both logical and imperative. Enshrining ESG values in business practice and transactions allows us to make a long-term, positive impact not only on the assets we manage, but on the environment in which they stand. That is something worth striving for.
