As I’ve written previously on our blog ESG reporting is of increasing importance to many of our clients. For listed companies it’s a mandatory requirement, for privately owned businesses its increasingly an essential best business practice, writes Thom Wilkinson, a Partner in our Property and Environmental Law team.
Environmental criteria address a company’s environmental impact and environmental stewardship.
Social criteria refer to how a company manages relationships with and creates value for stakeholders.
Governance criteria refer to a company’s leadership and management philosophy, practices, policies, internal controls, and shareholder rights.
In recent years, the appetite for tracking and prioritizing ESG factors in commercial property has dramatically expanded. International acceptance of climate change and the material risks associated with it has driven up investment in green buildings and clean energy infrastructure. Regulators working to address this problem continue to enact stricter policies and standards. Investors looking to make sound business decisions have an increased desire for transparency and stakeholder engagement. As a result, ESG has become a strategic imperative for portfolios in order to create and sustain long-term value in a rapidly changing world.
What are the benefits of ESG?
Organisations that adopt and invest in ESG strategies can improve corporate reputation and culture, enhance risk reduction and opportunity management, and increase intrinsic value. Commercial property firms with sophisticated ESG strategies can increase asset value, lower operating costs, and unlock sustainable financing opportunities.
For commercial real estate (CRE), environmental issues arguably have the largest and most easily quantifiable impact on portfolio risks and opportunities. Climate change is the number one risk (and number one risk accelerant) facing commercial real estate portfolios today. It worsens both conventional and ESG-related risks. An increase in natural disasters due to rising temperatures present significant threats – in terms of physical safety as well as the monetary impacts of insurance, maintenance, and repair costs. Other environmental issues include natural resource scarcity which can affect supply chains, and pollution and waste which cause health concerns and can potentially result in legal and regulatory ramifications.
When trying to understand the business impacts of environmental issues on commercial real estate, it is helpful to understand the three major risk categories they fall into.
Physical risks have tangible, quantifiable impacts. Climate change can physically impact portfolio assets and surrounding infrastructure. For CRE, a good ESG strategy addresses how to reduce disruption to building operations in the case of extreme weather events or long-term shifts in climate patterns.
Transition risks are due to market and non-market shifts, including changing consumer preferences, and shifts in climate and environmental policy and associated technologies. For CRE, a good ESG strategy will address how to reduce exposure to climate-related transition risks, such as changes in energy sources, shifts in energy costs, and enhanced energy and emissions reduction and reporting laws.
Social risks focus specifically on the impact on humans. For CRE, a good ESG strategy will prioritize the development and operation of buildings that are safe for occupants and the surrounding community. To inform your strategy, take stock of building safety and materials, contamination potential, health codes, emergency response plans, and occupant and community needs.
Unlike the “E” in ESG, the “S” is harder to measure at the asset level. The social dimension of ESG calls on you to invest in placemaking and explore how your assets deliver value for the communities in which they are located, beyond purely offering a place of employment. The welfare of communities that supply materials, house assets, production sites, and labour are linked to the welfare of company interests, improving (or harming) your bottom line and reputation. Financial and in-kind contributions to community causes may mitigate ESG-related issues that threaten both the company and the local community.
Looking beyond individual assets, the social dimension addresses company practices around human rights and labour management, including those of suppliers and other partners; as well as human capital management. For example how are you compensating for the skilled labour shortage?
Governance Issues
For commercial real estate, governance has less to do with individual assets or even portfolios, and more to do with how a business is structured and led, and how decisions are made. For example, an executive compensation structure tied to ESG benchmarks and a board-level ESG committee is a sign that the company is fully integrating ESG issues into their enterprise risk management system and long-term planning.
For a basic understanding of your company’s corporate governance think about these questions.
- What does your executive compensation structure look like? Is it tied to ESG benchmarks?
- What business ethics does your company subscribe to? How transparent are you with stakeholders? What kind of reporting practices are in place?
- Who is on your board? Are they diverse and representative of relevant stakeholders?
Good governance practices directly impact an organisation’s ability to build investor, tenant, and community trust. Corporate governance structures that adopt ESG frameworks are better equipped to suss out changing conditions that could negatively impact operations, including stakeholder opposition, boycotts, government fines and litigation.
Materiality assessment and a risk assessments
At a basic level, a materiality assessment consists of ranking the importance of environmental, economic, and social impacts by plotting these issues on an axis of importance to stakeholders (low to high) and an axis of importance to business success (low to high). Establishing which quadrant each issue falls into will help you prioritize issues and allocate resources effectively.
Once you have an idea of your priorities, perform a risk assessment that encompasses the physical, social and transition risks to your portfolio, including existing assets, new acquisitions and loan originations. Your risk assessment can be as broad or as narrow as necessary, focusing on a wide array of ESG considerations, or perhaps honed in on climate-related threats as an actionable and concrete starting point. If need be, deploy your risk or asset management team to perform on site assessments for your highest-risk assets.
For our commercial property clients looking to tackle the “E” in particular, the most robust approach to managing greenhouse gas emissions over the long haul is setting and committing to science-based targets. For those looking to deepen their impact across the board, aligning existing goals, targets, and programs with the Sustainable Development Goals is a good way to start.
ESG Frameworks and Standards
The Carbon Disclosure Project (CDP) is an international non-profit based in the United Kingdom, Germany and the United States of America that runs the global disclosure system for investors, companies, cities, states and regions to manage their environmental impacts. It has one of the most comprehensive dataset on corporate and city action.
GRESB, is the Global Real Estate Sustainability Benchmark, a leading ESG benchmark for real estate and infrastructure investments across the world. It provides standardized and validated Environmental, Social and Governance data to the capital markets.
The International Sustainability Accounting Standards Board (SASB) is an independent non-profit organisation that sets standards to guide the disclosure of financially material sustainability information by companies to their investors. ISASB Standards identify the subset of ESG issues most relevant to financial performance in different industries.
The Task Force on Climate-related Financial Disclosures (TCFD) was created by the Financial Stability Board to improve and increase reporting of climate-related financial information. Its recommendations enable more informed investment, credit, and insurance underwriting decisions and, in turn, enable stakeholders to understand better the concentrations of carbon-related assets in the financial sector and the financial system’s exposures to climate-related risks.
Green Building Certifications
The Building Research Establishment Environmental Assessment Method (BREEAM) is the world’s leading sustainability assessment method for master planning projects, infrastructure and buildings. It recognizes and reflects the value in higher performing assets across the built environment lifecycle, from new construction to in-use and refurbishment.
LEED (Leadership in Energy and Environmental Design), from the UK Green Building Council, is the most widely used green building rating system in the world. It provides a framework for healthy, highly efficient, and cost-saving green buildings. LEED certification is a globally recognized symbol of sustainability achievement and leadership.
There are many useful sources of information. A fuller explanation of how ESG impacts the property sector can be found here on Aquicore’s website.
Two other useful ESG resources are the UK Green Building Council, and the ESG Foundation, which curates an up to date library of ESG reports, topical ESG related podcasts and articles.
Contact our Property Team
At Bishop & Sewell, we have more than 40 years’ experience in property with a particular focus on Landlord & Tenant.
If you would like to discuss any of the points raised in this article, please do get in contact, quoting ref CB395. Thom Wilkinson is a Partner specialising in Property and Environmental Law and is contactable on: +44 (0)20 7692 7581 or twilkinson@bishopandsewell.co.uk
The content of this note should not be considered legal advice and each matter should be considered on a case-by-case basis.
