ESG Data is Growing Up

We are entering a new era of ESG data. Historic market failures regarding our negative environmental and social impacts, and the resulting climate change, nature loss and social inequality, are starting to be corrected with structural changes to the market.

In the financial sector, we are seeing both dynamic and double materiality becoming an integral part of decision making. The WEF introduced the concept of dynamic materiality in 2020, where an ESG topic which is financial immaterial today can become material tomorrow. That is coupled with double materiality, which considers both the inside-out view of ESG, that is what impact does an asset have on the environment and society, as well as the outside-in view of what impact environmental, social and governance issues have on the asset.

Climate change and carbon pricing is a good example. In terms of dynamic materiality, an increasing number of companies are adopting an evolutionary internal carbon price to drive low carbon investment in real assets and to mitigate the risks of cost increases as climate change externalities are corrected in the economy – this price will increase over time making financial materiality more likely across all sectors. There is an obvious point of connection here with double materiality, which is that real assets create emissions and will inevitably face more regulations over time – see the PRI Inevitable Policy Response Forecast Report. As our climate changes we will see an increase in severity and/or frequency of extreme weather events which can damage and disrupt real assets. All of these aspects of potential materiality have to be considered in financial appraisals and investment-grade ESG data can provide insight on trends and relative performance of assets.

Investment and Asset Managers are using ESG data from assets to make investment decisions: choosing the right assets to acquire and dispose of; deciding how to finance improvements to those assets; and investment & credit risk management processes are now incorporating ESG data. 

Those processes and decisions are becoming more transparent to the providers of capital, so the quality of ESG data has to become investment grade.

The expectations from investors, and their asset managers, of ESG data is closing the gap with the financial and commercial data captured in asset management software, but the budgets invested in ESG data management software and processes is vastly different. ESG data is now more valuable than it has ever been before and financial regulations are going to increase that value. 

The EU Action Plan for Sustainable Finance, and similar changes to UK financial regulations, means that the duties of asset managers & lenders and the decision they take about ESG risks and opportunities are no longer optional.

Without investment-grade data about ESG performance and sustainability actions then it is not possible to understand the full impact on asset value. ESG risk, in particular climate risk, is a financial risk and this data should be incorporated into every financial decision. 

That wasn’t the case last year, so this change is happening quickly. 

ESG data was being used in-house to monitor performance, as it has been for the last decade or so. It was used for annual reporting and for voluntary disclosure. There was a small minority of investors asking about ESG at the start of 2020, but throughout the pandemic this has changed quickly. Last year, there was not a fiduciary duty to be discharged based on ESG data. Nor staff incentive programmes based on ESG measurements. That has all changed as the market has grown up to take a more sophisticated view of how our economy relies on natural and social capital, not just financial and manufactured capital. The materiality of ESG has been recognised across the financial sector.

The financial markets are undergoing a structural change. Sustainable finance, and particularly climate-related finance, is now a global priority. This has led to changing investor requirements and regulatory changes for banks, institutions and fund managers, such as SFDR, MiFID ii and mandatory TCFD reporting are all combining to bring about structural change. We now have to consider dynamic and double materiality and make financial decisions accordingly.

It is slowly, but surely cascading down to real assets: real estate, infrastructure and land.

For those experts in sustainable real estate and infrastructure, it is clear that assets are likely to be mispriced and that the transparency provided by these regulatory requirements for ESG data will make that clear. Without ESG data on performance and actions, it is not possible to assess the cost of transition. For real assets, there is not a trading solution to disperse all of these liabilities by disposing of them to others. There is a need to retain, rethink, invest and dispose based on early knowledge of ESG risks. The later this happens the most likely it is that asset owners will see value erosion through reduced income, defaults, decreasing exit values and cap rate compression.

ESG transparency will also influence tenants and the users of real assets. There is a reputational risk of not taking sustainability performance seriously enough. Now that people have more choice about where they work and live, this risk could be more material to income and asset value than ever before.

At EVORA Global, with our SIERA and SIERA+ software, we are making these risks more visible and manageable. This is enabling our clients to make proactive decisions about their assets and funds, and to effectively engage with investors and other stakeholders.

It is time to approach ESG data in a new way. The historic policies, processes and procedures may no longer be fit for purpose. Most of them are only backwards-looking and there is now mandatory requirements to be forward-looking, which has its risks and uncertainties. In choosing an ESG data management platform ensure that it is future-proof, aware of this rapidly changing financial landscape.


If you would like to get in touch with the EVORA team, you can do so by filling in our form or by emailing contactus@evoraglobal.com

Nature: the next challenge for sustainable finance?

If there is one thing we’ve learnt from spending more time inside our homes over the last year, courtesy of these ‘unprecedented circumstances’, it is the importance of spending time outside.

The natural environment is a key part of our built environment. Access to green space has never been so desirable. And in our cities, where space is a premium and populations are growing, there are innovative ways to maximise our access to nature.

Encouraged by sustainable building certifications and a growing trend for biophilic design (the concept of increasing occupant connectivity to the natural environment), many buildings now incorporate additional greenery, with everything from your standard pot plant, to indoor trees and living walls and roofs.

The health and wellbeing benefits of increasing access to nature are well documented.

Improved air quality, increased productivity, and decreased stress are just a few of the most widely accepted. So it’s not surprising that research has also shown that increasing nature increases property values. We all know the rooms with the view attract a premium, and according to a report commissioned by the Natural Resources Defence Council, improved landscaping can add around 22% to the rental rates for retail buildings. And that’s before we account for the climate resilience impacts of incorporating green infrastructure – sustainable urban drainage systems help manage surface water flooding, living roofs can mitigate overheating and trees prevent soil erosion.

But we are realising the importance of nature at a critical time. Biodiversity is decreasing at an alarming rate. Between the combined pressures of climate change and humancentric land use, space for nature is dwindling and with it the enormous diversity of species on our planet. Indeed, scientists estimate that vertebrates have declined by an average of 70% in the last half-century.

Policy changes are moving in on the issue. The new London Plan brings with it the Urban Greening Factor, a measurement that will ensure London gets greener as it grows. On a larger scale, in the UK, the (much delayed and eagerly anticipated) Environment Bill will enshrine Net Biodiversity Gain into law, meaning that all new development must demonstrate an increase in nature compared to what was on site before.

In the investment space, we are seeing major changes too. Earlier this year France introduced a new disclosure regulation, Article 29, requiring French financial institutions to disclose biodiversity as well as climate-related risks. France’s Article 29 is a sign of what is to come in sustainable finance. Also established this year is the Taskforce on Nature-related Financial Disclosure. TNFD is a market-led initiative focused on standardising nature-related financial disclosures and mitigating biodiversity impacts. With TCFD we have seen a shift in climate-related financial disclosures, and TNFD is set to do the same for nature.

All this points to one thing: the next frontier in sustainable finance is nature.

If you would like to find out more, please get in touch with one of our ESG experts by contacting contactus@evoraglobal.com

Will Minimum EPC ratings of B come into force?

Before we consider EPC B ratings becoming minimum standards, let us explore where we are today.

Minimum Energy Efficiency Standards were introduced on 1 April 2018.  Buildings cannot be leased with an EPC worse than an E rating. There are exemptions, notably, a seven year payback rule exists.  Landlords can continue to lease buildings with F or G ratings if they can prove that energy savings from improvements cannot payback within seven years.  The exemption only lasts for five years, has to be registered on-line, and it does not transfer to new owners. 

Has this piece of legislation made a difference?  Yes. 

Whilst it is flawed, (are based on calculated rather than actual performance and the gap is too big) it has focused the industry’s mind.  Refurbishments have needed to achieve more sustainable design choices in order to meet the minimum EPC standards.  It is very unlikely that a real estate investor will now acquire a building without considering EPC ratings.  EPCs of F and G often result in a red flag during due diligence– unless the acquisition plans to focus on redevelopment or major refurbishment.

In my experience, the introduction of minimum energy efficiency standards has had an impact – far from seismic, but an impact none-the-less. 

As a minimum, landlords are considering EPC risk and working out how to improve performance at asset and portfolio level.

Future Changes

In October 2019, the Government consulted on proposals that would tighten non-domestic minimum energy efficiency standards to set a long-term regulatory target of EPC B by 2030, or the highest EPC band a cost-effective package of measures could reach.

The Government has recently issued a further consultation – which closes on 9th June 2021 – focusing on implementing a future minimum standard of EPC level B.  Below, we explore some of the key points:

  • The Government has confirmed a future trajectory of minimum EPC rating of B by 2030.
  • This will be phased in with an interim minimum rating of EPC C by 2027.
  • There is a proposed move away from enforcement at the point of let, to a temporary 6-month exemption to address the challenges of compliance for shell and core premises
  • There is a proposed obligation on letting agents and on line platforms to only advertise properties compliant with future regulations
  • There is a recognition that enforcement needs to be stronger
  • There is a recognition that exemptions need to be tightened and plans for introduction of a standardised payback calculator.
  • The government also recognises and highlights the importance of using smart meters to monitor energy performance – although EVORA recognise this will not improve EPC ratings directly.

Conclusions

Whilst it is a consultation, EPC B ratings – as a minimum – are on their way.

  • The UK Government has made significant climate change commitments.  It needs legislation to help drive progression.
  • Buildings contribute significantly to carbon emissions in the UK.  Action across the real estate industry must be taken to help achieve commitments.
  • The need to address climate change risks is increasingly obvious. 
  • EPCs however, flawed, provide a measurable approach.

In EVORA’s opinion there is a need to ensure that modelled energy (through EPCs) and actual performance is also thoroughly addressed.

If you would like to discuss the EPC ratings in your buildings, you can get in touch with our experts at contactus@evoraglobal.com


The full consultation document can be found here: https://assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/file/970192/non-domestic-prs-mees-epc-b-future-trajectory-implementation.pdf